Table Of ContentCONTRIBUTIONS
TO
ECONOMIC ANALYSIS
193
Honorary Editor:
J. TINBERGEN
Editors:
D. W. JORGENSON
J. WAELBROECK
NORTH-HOLLAND
AMSTERDAM · NEW YORK · OXFORD · TOKYO
INVESTMENT AND
FACTOR DEMAND
Patrick ARTUS
Caisse des Dépôts et Consignations (CDC)
and Ecole Polytechnique, Paris
Pierre-Alain MUET
Observatoire Français des Conjonctures Economiques (OFCE)
and Ecole Polytechnique, Paris
1990
NORTH-HOLLAND
AMSTERDAM · NEW YORK · OXFORD · TOKYO
ELSEVIER SCIENCE PUBLISHERS B.V.
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The present volume is a revised, expanded and updated translation of
'Investissement et Emploi', Paris, Economica, 1986
Translated by Jonathan Mandelbaum
ISBN: 0 444 88105 0
©ELSEVIER SCIENCE PUBLISHERS B.V, 1990
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PRINTED IN THE NETHERLANDS
INTRODUCTION TO THE SERIES
This series consists of a number of hitherto unpublished studies, which are intro-
duced by the editors in the belief that they represent fresh contributions to economic
science.
The term "economic analysis" as used in the title of the series has been adopted
because it covers both the activities of the theoretical economist and the research
worker.
Although the analytical methods used by the various contributors are not the same,
they are nevertheless conditioned by the common origin of their studies, namely
theoretical problems encountered in practical research. Since for this reason, busi-
ness cycle research and national accounting, research work on behalf of economic
policy, and problems of planning are the main sources of the subjects dealt with, they
necessarily determine the manner of approach adopted by the authors. Their
methods tend to be "practical" in the sense of not being too far remote from appli-
cation to actual economic conditions. In additon they are quantitative.
It is the hope of the editors that the publication of these studies will help to stimulate
the exchange of scientific information and to reinforce international cooperation in
the field of economics.
The Editors
Vil
Foreword
Economists differ as to the relative importance of the factors that determine
business investment. Some analysts assign a key role to market prospects,
others to realized profits, debt constraints and interest-rate levels. Until
recently, econometric studies of investment pitted these different approaches
against one another without ever successfully reconciling them in a coherent
theoretical framework. One of the prime contributions of the disequilibrium
theory to the econometrics of investment has been to furnish a clear and
comprehensive behavioral interpretation for the main models used in
empirical studies. By taking account of the constraints under which firms
operate, we can describe the coexistence of several potential determinants of
investment. The relative importance of these varies in response to the
economic cycle.
More recently, refinements in econometric techniques have made it possible
to produce numerical estimates of multi-regime models. This has enhanced
economic analysis by enabling periods to be distinguished according to their
prevailing types of behavior. In addition, the present authors have gradually
incorporated into their studies on French data the advances of economic
theory in such areas as decisions under uncertainty, behavior interdependence
and adjustment dynamics.
The first part of the book presents an estimate of the conventional
investment models, their interpretation in terms of disequilibrium, and their
application to an assessment of economic policy during the 1970s. Chapter 2
opens with an investment-model typology based on the inclusion of constraints
expected or perceived by firms, and on the extent of capital-labor substitution.
via Foreword
The chapter goes on to set out an estimate of the various models using
annual time series. Chapter 3 elaborates on the hypotheses about
production-technique choices and capital malleability by taking a new
comparative look at the "putty-putty" and "putty-clay" models. Chapter 4
studies the fiscal, taxation and monetary policies that have affected investment
since the first oil crisis, and assesses their macroeconomic impact with the aid
of the METRIC model.
The second part illustrates the interdependence of decisions concerning
investment, labor, and consumption of raw materials and energy. For this
purpose, we use a joint estimate of factor demands. Chapters 5 and 6 study the
joint determination of investment and labor in two alternative hypotheses :
absence of constraints (notional demand) or, on the contrary, demand
constraint (effective demand). Chapter 5 is confined to the technological
dependence between labor demand and capital demand. We show that factor
costs have a much more limited influence than demand, and that labor reacts
more promptly than investment to the various explanatory factors. Chapter 6
explicitly introduces adjustment costs into the calculation of factor demand. It
also incorporates an error-correction process into the formation of demand
expectations. The conclusions of this chapter corroborate those of the
preceding one: capital-adjustment costs are higher than labor-adjustment costs,
and the model with no demand constraint does not yield credible results.
Chapter 7 extends the analysis of substitution effects to include intermediate
energy consumption. This factor is complex, for the influence of energy cost
on capital accumulation depends not only on the substitution between the
"capital + energy" bundle but also on the direct substitution between capital
and energy. The influence can therefore be positive or negative. Chapter 7
presents an estimate of three-factor demand functions for the main OECD
countries that enables us to interpret the contradictory results previously
Foreword i*
obtained through cost functions.
The final chapters implement the latest econometric theories and methods.
These are first applied to the estimate of a multi-regime investment model
incorporating output, labor, and financial constraints (Chapter 8), then to the
joint determination of investment and labor in a context of demand
uncertainty (Chapter 9).
X
Acknowledgements
This volume is a collection of theoretical and applied studies on the
econometrics of investment and employment in France published by the
authors over the past decade.
Most of these articles initially appeared in French journals : Revue
Economique (Chapter 1), Observations et Diagnostics Economiques
(Chapter 4) and, for the most part, Annales de l'INSEE (since 1985, Annales
d'Economie et de Statistique) (Chapters 2, 3, 5, 6, 7 and 9). We are grateful
to the editorial boards of these periodicals for permission to reprint our
contributions.
We also wish to thank the co-authors of certain of these studies : Michel
Boutillier and Pierre Villa (Chapter 5), Bernard Migus (Chapter 6) and
Claude Peyroux (Chapter 7). Last but not least, we express our gratitude to
Marie-Christine Hurault and Christine Carl for their efficient assistance
during the production of this book.
3
CHAPTER 1
Theoretical foundations and main models*
by
Patrick Artus and Pierre-Alain Muet
Introduction
For the past two decades, the econometrics of investment has seen the
development of two distinct approaches, which we shall respectively define as
"explicit" and "implicit." Both derive the investment function from a behavior
that consists of an intertemporal maximization of the firm's profit. The
"explicit" approach pioneered by Jorgenson [1963] links investment to
variables that determine its profitability — in particular by incorporating
production-function parameters. By contrast, the "implicit" approach
introduced by Tobin [1969] seeks to measure that profitability directly on the
basis of the stock-market value of assets. While the second approach has
recently given rise to new theoretical developments, its econometric relevance
cannot be compared to that of the first approach, which has more successfully
integrated earlier models such as the flexible accelerator, first empirically
(Jorgenson [1963]; Eisner and Nadiri [1968]; Bischoff [1971]; etc.), then
theoretically (Grossman [1972]).
The first section of Chapter 1 presents the theoretical foundations of the
models. The second section compares the main econometric estimates by
analyzing the impact of growth, factor costs and financial conditions on
investment.
1. THEORETICAL FOUNDATIONS
We shall begin with a highly simplified presentation of the main
investment models, using a model in which labor is instantaneously adjusted
whereas the change in capital requires a one-period lag. Thus investment
demand in period (t) results from the capital desired by firms for the period
(t+1). Choosing as decision criterion the maximization of discounted profit, we
* Originally published as "Un panorama des développements récents de l'econometrie de
l'investissement," Revue Economique 35(5):791-830, Sept. 1984.
4 Investment and Factor Demand
shall in turn describe the main investment models in terms of the constraints
perceived or expected by firms in the markets concerned by the investment
decision. This leads us to distinguish between notional demand, which depends
solely on factor costs, and effective demands, which depend on expected
constraints on the various markets. Lastly, by introducing uncertainty or
adjustment costs, we can validate the main results obtained through the implicit
approach (Tobin's q).
1.1. Conceptual framework
Q, L, K and p, w, q respectively designate the volumes and prices of
t t t t t t
output, labor and capital at the date t (stocks defined at the start of the period).
I stands for investment volume.We assume that prices and costs (p, w, q) are
t t t t
given for the firm. The same obviously applies to the capital stock available at
the start of the period (K). The decisions of firms therefore concern the
t
quantity of output (Q), labor (L) and investment (I) for the period. I is
t t t t
linked to the capital stock desired for the period (t +1) by the standard
equation:
t+1 (ΐ+δ)
which assumes an exponential depreciation at the rate δ .
Technical constraints are represented by the production function with
substitutable factors:
(2·) ο^ίας,ί,);
(2··) Q <f(K ,L )
t+1 t+1 t+1
In keeping with the conventional analysis, we assume that firms base their
production, employment and investment decisions on the maximization of
discounted profit. In the simplified framework used here, where capital is
treated as perfectly homogeneous and malleable, this maximization is restricted
to the current period and the period after it. Discounted profit over the two
periods (in other words, the increase in the firm's value over the two periods)
is equal to:
