ECONOMY: INVESTMENT IS one of the most important drivers of economic growth. It might only account for 20 per cent of GDP (comparedwith consumer spending which is usually over 50 per cent), but it is investment which produces new output and sales and, usually, gives rise to job creation, writes MICHAEL CASEY

It often has second-round effects which boost activity in other sectors of the economy.

We are not talking about investment in stocks and shares; but investment, in the national accounts sense which is capacity-building investment in new assets, such as plant, machinery, equipment, computers, factories, offices, infrastructure and of course housing - the seed-corn of the economy.

The latter is not all that productive; indeed some economists have argued over the years that our national obsession with home ownership has actually diverted resources away from more productive investment. In any case house-building is not likely to recover any time soon, given the large stock of unsold houses that exists at the present time.

But is there any way we could stimulate the other forms of growth-inducing investment? Most forecasters believe that investment in machinery and equipment fell in real terms in 2008 by about 12 per cent and is likely to fall by the same percentage in 2009. This is very worrying because even when investment does pick up there may be a considerable time lag before the rest of the economy follows suit.

Part of the problem is that there is something of a vicious cycle at work. Entrepreneurs don't want to risk new investment unless the economy shows some signs of picking up. But, at the same time, unless new investment takes place, it will be difficult for the economy to recover. This forms part of the thinking in the recent UK budget which aims to stimulate consumer spending first in the expectation that this will encourage investment.

The Irish budget had no such strategy but, in the event, the general Government deficit is likely to be much larger than predicted - probably over 8 per cent of GDP - with the result that some form of stimulus will be provided, because the figures were wrong.

There are a couple of other variables which influence investment. One is the interest rate. A low interest rate, in real terms, should stimulate investment, other things being equal. Of course we have no control over interest rates anymore. During the Celtic Tiger, the gap between the real interest rate and the real growth rate was amazingly wide.

We know the affect that this had on the housing market, but it also induced different sorts of investment which were profitable as long as the economy continued to grow rapidly. Many small businesses were set up because of this factor. When the growth of the economy eventually slowed down, many of the investments proved to be sub-optimal and indeed not profitable at all.

Now that the growth of the economy has become sharply negative (and interest rates haven't fallen in real terms) many business people are finding it hard to service their existing loans. Many businesses are closing and, unfortunately, there may be many more to follow. It never seemed to occur to Government that by hyping up the economy they were storing up serious trouble for business people and consumers.

Other factors which are supposed to influence investment are more psychological in nature. However, at this stage in a recession it is hard to see these impulses having much effect. In fact, by denying recession for so long, the Government has made the psychological effects worse. Despite straws in the wind for several years, the official hype encouraged consumers and investors alike to get more and more into debt - with the result that there is now real alarm in the community.

Thrift is good in the long run, but in a recession you need people to spend. However, it is hard for people to spend when they are heavily in debt and worried about losing their jobs and businesses.

There is some possibility that if existing retail businesses lower their prices - and for once do right by their customers - they might stimulate consumer spending to some limited extent. This in turn could pay dividends in terms of new investment. But deflation could be a problem here. If people believe that prices may fall even more the following year, they won't spend now.

The laws of supply and demand do seem to be working after an initial lag. House prices are falling; retailers are having sales even before Christmas. Rents are falling. This may provide opportunities for new entrepreneurs to take over existing premises and start new businesses.

The public capital programme should be front-loaded if possible to get infrastructural investment going at an early date. The only caveat here is value for money, but if that can be assured, large labour-intensive PCP projects should be started. Building workers spend a lot of money which boost other areas of the economy.

In sequencing the projects consideration should be given to those which utilise a high proportion of home-produced materials and components. CSO data can be used to identify these projects.

The other main source of investment is foreign direct investment. Relevant staff from other areas of the public sector should be seconded to the Industrial Development Authority to help in attracting foreign investment, especially from the US. It is to be hoped that a vigorous lobbying process has already begun in relation to President-Elect Obama's views on US multinational companies and their overseas investments.

It is to be hoped that the new group set up to curb expenditure in the public sector (An Bord Snip Nua) does not target important infrastructural projects which sometimes are relatively easy to postpone or abandon from a political perspective.

There would be merit in setting up a second group of economists, engineers and IDA experts to examine ways of shortening the recession and preparing the economy for recovery. Hype and spin have failed; we now need well-conceived initiatives.