In a broad sense, all investments are alike: You spend money or commit resources now in the hope of earning a return later. Go just a bit deeper, however, and you see significant differences in the way investments are expected to pay off. Economists draw a key distinction between economic investments, which generate wealth through economic activity, and financial investments, which generate wealth primarily through finance -- the manipulation of money.
Management professors Krishnamurthy Nagarajan and G. Jayabal define economic investment as investment that increases the "capital stock" of society -- in other words, it increases production capacity. Economic investment allows companies to provide more or better products and services. New buildings, equipment and vehicles obviously represent economic investment, but so can spending on education and health care. Those things improve "human capital," making workers more productive.
A share of stock is a quintessential example of a financial investment. If you're like most investors, when you buy a share of stock, you're not planning to "do something" with it. You're not going to use it to increase production of anything or improve the quality of any products. You buy it with the hope that it will increase in value so when you sell it, you'll make money. In the meantime, you'd like to collect dividends -- regular payments from the company that issued the stock. Nothing new is directly created from a financial investment; rather, as Michael Douglas Gilbert writes in "America in the Economic World," a financial investment simply represents an asset changing hands. Other examples can include bonds; gold and other precious metals, when purchased as a store of value rather than for industrial use; money earning interest in a savings account; and real estate that you don't develop or improve.
The Interplay Between Them
Financial and economic investments are not wholly separate; in fact, they're often inextricably linked. For example, companies sell shares of stock to raise money. The people buying those shares are making a financial investment. But the companies use the money for economic investments: buying equipment, upgrading facilities, developing new products. Those investments generate growth, which increases the value of the company, which raises the value of the stock -- a reward for the financial investors. From this perspective, then, financial investment is not just about moving money around. It's also about enabling economic investment.
Understanding the Difference
The distinctions between financial and economic investment often get blurry in common discourse. It's all "investment" -- and investment is generally regarded as a good thing. However, in his book "The Economic Process," economist Carmine Gorga warns against what he considers an intellectual trap: believing that the accumulation of wealth (financial investment) counts as a "productive" use of money (economic investment). Gorga's colorful term for this view is a "clear-cut break with reality." From this perspective, unless such wealth is actually put to use for productive ends, rather than sitting in an account, it's not benefiting the society's capital stock.
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