Investment Drives Growth More Than Consumption in Economies

Source: The post Investment Drives Growth More Than Consumption in Economies has been created, based on the article “Is consumption enough to drive growth?” published in “The Hindu” on 21st February 2025.

UPSC Syllabus Topic: GS Paper3- Economy

Context: The article explains that economic growth depends on both supply (production) and demand (expenditure). Investment boosts growth more than consumption. China’s fast growth was investment-led, while India relies more on consumption. India needs higher public investment to sustain long-term growth.

For detailed information on How to Boost Investment and Economic Growth read this article here

How Does Economic Growth Work?

1. Economic growth depends on both supply (production) and demand (expenditure). GDP measures the value added by production. Demand in an economy comes from four sources:

• Private consumption – Spending by individuals on goods like food, clothing, and mobile phones.
• Private investment – Spending by firms and households on new machines, factories, and homes.
• Government expenditure – Spending on salaries, public services, and infrastructure.
• Net exports – The difference between exports and imports.

2. If supply grows slower than demand, prices rise, leading to inflation. If demand weakens, firms accumulate unsold goods, leading to lower production, job losses, and slower growth.

Why Is Investment Important for Growth?

1. Among the four components of demand, investment has the strongest multiplier effect. A ₹100 investment can increase GDP by more than ₹100 (e.g., ₹125 if the multiplier is 1.25).
2. For example, public investment in highways creates jobs for construction workers and businesses. It also enables new businesses and industries to develop. The multiplier effect is stronger in underdeveloped regions compared to areas with existing infrastructure.
3. Compared to investment, consumption has a weaker multiplier effect. Higher incomes increase consumption, but rising consumption does not strongly increase incomes across the economy.

Why Did China Grow Faster Than India?

1. Similar Start: In the early 1990s, India and China had nearly the same per capita income, around 1.5% of U.S. income.
2. Faster Growth: By 2023, China’s per capita income was five times India’s. In purchasing power terms, it was 2.4 times higher.
3. Higher Investment Rates: In 1992, China’s investment rate was 39.1%, while India’s was 27.4%.
4. Post-2008 Crisis Response: China raised its investment rate to 44.5% in 2013, while India’s declined to 31.3%.
5. Investment in Key Sectors: China focused on infrastructure, advanced manufacturing, renewable energy, and artificial intelligence.
6. India’s Weakness: India’s investment slowed after 2012, while consumption became the dominant growth driver.

What Should India Do?

1. To boost long-term growth, higher public investment is needed. This would encourage private investment and help spread economic benefits to more people.
2. However, the government has not significantly increased investment spending in recent budgets.
3. Instead, it has given tax concessions and focused on middle- and upper-class consumption, which may lead to a low-growth trajectory.

Question for practice:

Examine how investment contributes to economic growth and why it has a stronger impact than consumption, using the examples of China and India.