How does capital investment (factory, plant, etc.) benefit the region they are located in?

Generally, capital investment is always good for the economy, but I am not sure about the underlying mechanism. For example, if a car factory is built in a certain state, does it improve the economy solely by creating jobs and generating car sales thereby increasing the regional GDP?

I’ve also another related question. I often read that states in the U.S. frequently fight for large capital investment in their respective regions from a certain company, I’m assuming it would boost the economy tremendously. However, if a factory (lets say it’s located in state A) ONLY ships and sells its products to state B, would it improve state A’s economy as much as if sales were only made in state A?

My hypothesis is that the factory in would still improve the economy in state A due to the creation of jobs and its overall costs of production (purchasing from other businesses in the area), although it wouldn’t boost the economy as much as it would in the other scenario.

Please correct me if I happen to have said anything wrong.

4 Answers

There are more effects for economy then just what you mentioned.

For example, if a car factory is built in a certain state, does it improve the economy solely by creating jobs and generating car sales thereby increasing the regional GDP?

Not only because of this there are also other effects. Depending on what kind of investment it is it can support technology transfer between the countries or also increase stock of human capital (through on job training/learning by doing), which according to endogenous growth theories can accelerate economic growth itself (although it is worth noting endogenous growth theory is still not completely accepted by profession even though Romer who developed it even received Nobel Prize for it because it’s hard to test).

Moreover, apart from such dynamic growth effects there are more beneficial macroeconomic effects on GDP. From macroeconomic perspective all spending including investment has a multiplier attached to it. For when the factory increases GDP by the investment people will also have more money to spend increasing GDP even further and so on. From macroeconomic perspective your spending/investment is someone’s else income so if you increase your spending/investment other people will spend more as well.

Also aside from macroeconomic effects any new job openings put upward pressure on wages, however depending on how many jobs are offered and what is already situation in the market this effect might be very small.

if a factory (lets say it’s located in state A) ONLY ships and sells its products to state B, would it improve state A’s economy as much as if sales were only made in state A?

Not really as measured by GDP. The GDP identity is given by:

$$GDP= C+I+G+X-M$$

Where C is consumption I investment G gov. spending, X export and M import.

So even just looking at the identity it is possible to see that if the cars are not consumed but exported GDP does not change.

However, there is even more to it. Trade theory in economics tells us that there are both static and dynamic gains from trade. Hence to the extent that the cars are exported because in state A they can be produced more efficiently then in state B, and in exchange state B trades to state A some of its products that they can produce more efficiently there will be both static one time increase in the level of their welfare from specialization, and also potentially some dynamic effect assuming that the longer the state specialize in the good they have comparative advantage in the better they become at its production.

It really depends on how far the factor/company is from state B. Obviously, it would be a big boon to state A.

When a factory opens in a local economy many things does happened outside of job gains. Like increasing the Tax Base: local businesses increase their tax dollars stay within the local economy, helping to improve their community as a result.

To answer your question about state B, if the factory is close enough yes it can provide economic benefit as well.

And according to Tober’s first law of geography (which is related to this situation) "everything is related to everything else, but near things are more related than distant things." Lets say the factor is located in the middle of Texas, the positive externalities of having the factor in the economy won’t have much of an impact in the local economies of, lets say, South Florida.

But if a factory is located in New Jersey then a local economies of, lets say, New York or Connecticut does get a boost as well. Not only in terms of jobs for residents and increased income but also Innovation and Competition.

With Innovation and Competition, having multiple small businesses in the same region all striving to be unique, innovative, and better can result in a healthy marketplace and well-served customers.

As those businesses needing factor goods from the factory that is close by will have less transportation costs to obtain materials.

One thing that could be made more explicit is that the capital is presumably for export employment and the existence of these employees will require additional local employment. Export employment is a job that produces a product for outside the city, local employment produces a good/service internal to the city.

To use your example, if a car factory brings an additional 5k people to a neighborhood, that neighborhood will likely also experience increased demand for private security, hairdressers, food delivery services, etc. The cars are for export, and the security, etc. are for local use.

In context, one might see behavior where the local government bids the car factory's taxes down to 0. The city may still see increased net tax revenue from the additional jobs created- private security, hairdressers, food delivery services. This gamble does not always work out in the city's favor however.

For more reading on regional/urban economics, see the textbook below, in particular Ch. 8:

O'sullivan, A. (2007). Urban economics. Boston, MA: McGraw-Hill/Irwin.

Capital investment is generally considered a positive for the economy in which the investment takes place because it increases productivity (more goods or services per unit labor input). To use a simple example, if you had a factory of people who hand sew dresses and then made a capital investment to buy sewing machines, those same people when trained to use the machines (another form of capital investment), the amount of dresses now increases per time spent per person. The result is now more goods (dresses) in the economy thus driving down prices over time.