Investment Models - Types with Examples & Affecting Factors. (2024)

Investing is the process of exchanging money for a profit-generating asset. Profits are also invested in other assets. Investment is vital for the country’s economic well-being since it encourages growth and advancement. Various Investment Models are used to enhance the investment environment and thus boost the socioeconomic development of a country. Investment Models specify the modes in which funds are invested in specific assets through which income is generated. Thus, Investment Models are one of the most important topics for the UPSC IAS Examination.

Investment Models

In this article on Investment Models, we shall discuss their meaning, types, significance, challenges associated, and a way forward. This will be very useful for aspirants in the UPSC Prelims Exam.

Also, study the 5-Year Plans in India from the linked article.

What is Investment?

• Investment is the process of putting money into productive activities to make money.
• It can be accomplished directly or indirectly (via various activities in the primary, secondary, and tertiary sectors, as in financial securities, such as shares, debentures, bonds, mutual funds, etc.)

Read about the Kisan Vikas Patra Scheme here.

Example of Investment

Consider potential investments in bank accounts, corporate stock, real estate, gold, a business, or an industry. A country must produce more goods and services to thrive (and create jobs for people), so investments in business, agriculture, industry, and supporting infrastructure are highly appreciated.

Importance of Investment in an Economy

• Investment refers to the government's procedures and techniques to raise essential funds (resources) to meet specific development goals.
• An economy's income, output, and employment level are dictated by effective demand, which is determined by expenditures on consumption and investment goods (Y= C + I).
• Investment is a component of aggregate demand; changes in investment cause the aggregate demand curve to shift by the initial change multiplied by the multiplier.
• The capital stock is affected by investment, which modifies the production possibilities curve and the economy’s aggregate production function.

Study the Priority Sector Lending (PSL) Scheme here.

Classification of Investments

The below mentioned are the types of investments:

Debt Investment

• Public and private debt-based investments are the two types of debt-based investments.
• These are debt assets that can be purchased or traded on public markets. These products include bonds, debentures, and credit swaps.
• Non-public (private) investments
• These transactions result in a balance sheet asset but are not easily or openly exchanged in marketplaces. One example is the purchase of another entity’s accounts or loan receivables.

Stock investments

• These are considered riskier than debt investments but have a higher profit potential.
• A public equity investment is any equity-based investment that can be bought or sold on the open market.
• People typically think of these types of assets when discussing investments.
• This includes, among other things, common stock, preferred stock, stock options, and stock warrants.
• Private equity investments are frequently larger-scale investments that are out of reach for the average small investor.

Study the Debt to GDP Ratio here.

Relationship Between Investment and GDP

GDP is defined as GDP = C + I + G + NX, where C represents consumer spending, G represents government spending, and NX represents net exports, calculated as the difference between exports and imports, X-M. Investment, or ‘I,’ equals the total expenditure after subtracting consumption, government spending, and net exports (i.e. I = GDP-CG-NX). [I → denotes total investment.]

Study the Alternative Investment Funds (AIF) here.

Factors Affecting Investment Models

There are many factors that can affect investment models, including:

Investment goals

The investor's investment goals will play a major role in determining the appropriate asset allocation and investment strategy.

Risk tolerance

Investors who are more risk-averse may prefer to invest in more conservative assets. Investors who are more risk-tolerant may be willing to invest in more aggressive assets.

Investment time horizon

Investors with a longer investment time horizon can generally afford to take on more risk. They will have more time to recover from market downturns. Investors with a shorter investment time horizon may need to be more conservative in their investments.

Market conditions

Investors may be more likely to invest in stocks during a bull market when stock prices are rising. Investors may be more likely to invest in bonds during a bear market when stock prices are falling.

Personal financial situation

Investors with a lot of debt may need to focus on paying down that debt before investing. Investors with a steady income may be able to invest more aggressively.

Study the Measurement of National Income here.

What is an Investment Model?

An investment model is a strategy or plan that outlines how investors intend to allocate their assets and invest their money. The model depends on the individual's investment goals, risk tolerance, and investment time horizon.

Major Types of Investment Models

The below mentioned are the types of investment models:

Public Investment Model

A government must have income (primarily tax revenue) to spend, but India's existing tax revenues are insufficient to cover the nation's planned expenditures. Therefore, India can only move further on the path to development with the involvement of private citizens; in reality, the government needs tax money from private investors to invest.

Private Investment Model

Private investment can come from India or anywhere else. They can be Foreign Direct Investment (FDI) or FPI from another country. In this age of globalization, we cannot say no to FDI or FPI because India’s current account imbalance is widening due to higher oil imports.

Why does India require private capital?

• To grow and increase income, a country’s production must be increased. More goods and services need to be manufactured.
• Transportation, electricity and communication infrastructure should all be developed to aid manufacturing.

Read about Inflation in Depth here.

Public Private Partnership (PPP) Investment Model

The term PPP refers to combining the best public and private initiatives.

Some of the project funding schemes are as follows

• Construct–operate–transfer (BOT).
• Build–own–operate–transfer is the acronym for BOOT.
• Own–build–operate (BOO).
• Create, construct, finance, and run (DBFO).

Read in detail about the Public Private Partnership here.

Flaws in PPP Model

• Two major challenges are a lack of capital and regulatory barriers relating to land acquisition.
• They’ve been used as a tool of crony capitalism and a means for private companies to acquire land.
• Many PPP infrastructure projects are overseen by “politically connected firms” that have secured contracts based on political ties.
• PPP is also described as a “linguistic game” utilised by governments who find it difficult to promote privatisation or political contracting.
• Several businesses have been “over-leveraging,” or bidding above their ability and expecting the government to redraw contracts, according to the 2015 Economic Survey.
• According to the Economic Survey 2015, PPPs contain design flaws such as no re-negotiation frameworks, which promote project stalling, erroneous risk allocation, which focuses on fiscal incentives rather than efficient service supply, and no way to penalize suppliers for poor service.

Check out the test series for UPSC IAS Exam here.

Reforms to strengthen the PPP model - Recommendations of the Vijay Kelkar Committee

• It called for improvements to the three main pillars of the PPP framework: governance, institutions, and capability. The research advocated the creation of a 3PI (public-private partnership institute of excellence) to complement institutional capacity-building activities.
• The 1988 Prevention of Corruption Act should be amended as quickly as possible to punish corrupt practices while protecting those who made honest mistakes.
• To obtain low-cost long-term borrowing, banks and financial institutions should be encouraged to issue deep discount bonds, often known as zero coupon bonds. During the project’s early stages, this will reduce loan payment expenses.
• After the projects are successfully finished, long-term investors, including foreign institutional buyers, may be offered equity. The money raised from the sale would go toward new infrastructural projects.
• Independent sectoral regulators should be established when a new sector is announced employing the PPP model.
• Regulators should work together to achieve their goals. With independent regulators, the initiatives would be protected from bureaucratic and political pressure.
• The Model Concession Agreement (MCA) should be revised to ensure all parties distribute risks fairly. Instead of taking a “one-size-fits-all” strategy, do a project-specific risk analysis.
• The government may draft a PPP law with Parliament’s assent. It provides an authoritative framework for adopting executives and oversight obligations for legislators and regulatory agencies.
• The infrastructure PPP Project Review Committee (IPRC) should be established to analyse stress in PPP projects and make timely recommendations.
• The Chairperson of the Infrastructure PPP Adjudication Tribunal (IPAT) should form the benches according to the demands of the case.

Read about the Goods and services tax(GST) here.

Alternative investment models

Depending on where the money comes from, the two alternative investment models,

• Public, private, and public-private partnerships are examples of domestic investment models.
• Model of Foreign Investment – It could be 100% or a combination of FDI and domestic investment.
• Many investment models depend on where the money flows (or how investments are planned).

They include:

• Specific Industry Investment Models (In SEZ or MIZ etc.).
• Cluster Investment Model (Eg: Food Processing Industries)
• Project Finance Schemes and Models: Models: A Brief Overview
• A road can be designed using a variety of models. Consider the following examples to grasp the concept.

Study the Mid-Day Meal Scheme here.

Investment Models in India

Harrad Domar Model

According to the concept, economic growth is based on policies that boost investment by increasing savings and maximising the use of those resources through technological advancements. It means that balancing the expansion of an economy is not a necessary condition. There was only really one section in the model. India could not draw in investments for consumer goods because it needed a strong capital goods industry.

Study the Population Composition Of India here.

Swan Solow Model

The Harrod-Domar model from 1946 was followed up by the neo-classical model, which introduced the concept of productivity growth. Model of Feldman-Mahalanobis: In the long run, having enough capital goods capacity increases the output of consumer products. The model's core is a change in industrial investment patterns towards creating a domestic consumption goods sector. It originally had two sectors, but it was increased to four over time. It is also known as the Nehru-Mahalanobis model.

Manmohan Rao Model

In 1991, Dr. Manmohan Singh and Narasimha Rao established the Economic Liberalization and Foreign Direct Investment programme. Lewis’ economic development model is predicated on an infinite supply of labor.

Read about the New Economic Policy 1991 in-depth here.

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We hope all your doubts regarding the Investment Models will be cleared after going through this article. You can check out our UPSC Online Coaching and download the Testbook App now to check out various other topics relevant to the UPSC IAS Exam.