Table Of ContentStudies in Contemporary Economics
Editorial Board
D. Bos G. Bombach B. Felderer B. Gahlen K. W. Rothschild
Marcel Savioz
New Issues in the
Theory of Investment
Modernization and Persistence Effects
Springer-Verlag
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Author
Dr. Marcel Savioz
Volkswirtschaftliches Institut
Universitat Bern
LaupenstraBe 2
CH-3008 Bern
ISBN-13 :978-3-540-54979-6 e-ISBN-13 :978-3-642-84691-5
DOl: 10.1007/978-3-642-84691-5
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ABSTRACT
This monograph is composed of three chapters. The first chapter gives a
survey of the field, the second presents a microeconomic investment model and
the third a macroeconomic investment model.
Chapter I: Investment Theory: an Integrative Framework
The first chapter gives a survey of investment theory using a costs of
adjustment model as integrative framework. First, we discuss the following
major investment hypotheses: Keynes's "Marginal Efficiency of Capital",
Jorgenson's "Neoclassical Investment Demand", Arrow's "Irreversibility of
Investment", Treadway's "Optimal Accelerator", Lucas's "Optimal Investment
with Rational Expectations", Tobin's "Q Investment Demand", and Abel's
reassessment of the "Q Investment Demand", as "special case" of the model.
Then we present two alternatives to the costs of adjustment model: Blanchard
and Sachs's "Disequilibrium Investment Model" and Kydland and Prescott's "Time
to Build". Through the "general to the particular" approach adopted in this
chapter, we could present key ideas of investment theory in a natural way.
Chapter II: Ageing of the Capital Stock and Fiscal Policy
The second chapter presents an investment model where the firm buys and
sells investment goods simultaneously. Through its investment (purchase of
"new" capital goods) and "disinvestment" (sale of "old" capital goods)
behavior the firm controls not only the size of the capital stock but also the
stock turn over of capital. Because we assume that new investment goods are
better than old ones, for a given size of the firm, a higher stock turn over
of capital increases the efficiency of production and the firm's output. There
are therefore two motives to invest: the first is to increase the size of the
firm (bigger capital stock) and the second is to increase the efficiency of
the firm through purchase of incorporated technical progress (better
capital equipment). This second motive is the modernization motive to invest.
VI
Beside depreciation through default of the capital goods and depreciation
through ageing of the capital goods, we introduced depreciation through use of
the capital goods into the model. The capital costs thus become dependent on
the intensity of use of the capital stock. These capital costs are therefore
"true" user costs of capital and generalize the rental costs of capital of
Jorgenson (1963) which are independent of the intensity of use of the capital
stock. We show that an investment model neglecting depreciation through use,
overpredicts changes in investment demand.
Because the age of the capital stock is in the steady state the inverse
of the stock turn over, the model can make predictions on the age of the
capital stock. It is shown that expansive fiscal policy increases the average
age of the capital stock permanently if depreciation through use is of a
non - negligible order of magnitude.
Chapter III: Persistence of Extensive Growth
The third chapter is a growth model of the Soviet Economy. Because in a
planning economy real savings adjust passively to investments, it is quite
reasonable to model the Soviet growth process using an investment model.
The model distinguishes between two types of capital goods: Plant and
Equipment capital (P&E) and Research and Development capital (R&E). Changes
in the investment mix: investment in P&E capital/investment in R&D capital,
are followed by changes in the capital structure of the economy and by changes
in the total factor productivity. The choice of an investment mix is thus also
the choice of a type of growth: intensive growth or extensive growth.
Although we assume rationality of the planning authority and perfect
planning, the model predicts that an economy whose growth process is very
extensive will face a growth slow-down and that the way out of this growth
slow-down can be very slow. This is simply because extensive growth is, as a
consequence of the "law of increasing relative costs", the costly way to grow.
According to this law producing more Plant and Equipment becomes more and more
costly, i.e. the more Plant and Equipment are produced the more Research and
Development investments are deterred.
VII
The model is a standard adjustment costs model with the exception of two
assumptions. First, increasing returns to scale are assumed. Second, we
assumed that the adjustment costs are non - separable in order to force the
substitution of P&E and R&D investment goods. In the standard formulation,
adjustment costs being separable, increased investment in one type of capital
good is followed by a decrease in consumption, without the deterring effect on
the investment in the other type of capital. Thus the law of increasing
relative costs between the two investment goods cannot come into action. The
interplay of the increasing returns to scale with the law of increasing
relative costs produces the persistence of extensive growth phenomenon.
The Unitying Feature
In the first chapter the standard one - investment - good model with one
motive to invest (increase the capital stock) is presented. The two following
chapters generalize this model. In Chapter II there is one investment good
(Plant and Equipment), but two motives to invest: increase the firm's size and
buy incorporated technical progress. In Chapter III there is a single motive
to invest (increase the capital stock) but two types of investment goods: a
tangible one (Plant and Equipment) and an intangible one (Research and
Development). The unifying feature of this monograph is thus to depart from
the standard "one relative price" investment theory; this relative price being
Tobin's Q. In the second chapter there is one Tobin - Q for investment, and one
for "disinvestment". In the third chapter there are two Tobin-Qs, one for each
type of investment good. Of course the advantage to restrict oneself to a
model with two investment motives or to a model with two investment goods is
analytical: the qualitative methods (phase diagrams) of solving systems of
differential equations are still available and global results can be attained.
The content of the three chapters is discussed in detail in the introduction.
Acknowledgments
I am indebted to my excellent teachers, Prof. Dr. Bombach and Prof. Dr.
Kugler, without whose inspiration and guidance this monograph would not have
been possible.
Special thanks are due to Mrs. Carole Rufener, whose expertise was very
helpful in improving my "English".
This monograph is based on a dissertation submitted at the University of
Basle.
To my friends Rolf Schmid and Fritz Ogi
who were too young to go.
TABLE OF CONTENTS
Introduction 1
Investment Theory: An Integrative Framework 3
1. The Main Problem of Investment Theory 3
2. The Main Approaches to Investment Theory 3
3. An Integrative Framework 7
Ageing of Capital Stock and Fiscal Policy 12
1. Description of the Model 12
The Modernization Motive to Invest 12
Replacement Investment 13
Production 16
The Approach Chosen 18
2. Predictions of the Model 20
Product Innovation and Investment Activity 20
Types of Technology and Disinvestment Activity 22
Sluggish Adjustment Caused by Depreciation 24
Ageing of Capital Stock 25
Persistence of Extensive Growth 27
1. Description of the Model 27
Extensive Growth of the Soviet Planning Economy 27
The Law of Increasing Relative Costs 28
Increasing Returns to Scale 29
The Approach Chosen 30
2. Predictions of the Model 32
Stylised Facts of the Soviet Growth Process 32
Persistence of Extensive Growth 32
Brezhnev's Slowdown 33
Growth Policy and Reform 33
XIV
Chapter I Investment Theory: An Integrative Framework 35
l. Introduction 37
2. The Model of the Firm 37
3. The Investment Decision of the Firm 44
3.1 Necessary and Sufficient Conditions 44
3.2 Economic Interpretations 45
4. Tobin's "Q - Investment Demand" 48
5. Treadway's "Optimal Accelerator" 50
5.1 A Simplified Capital Accumulation Problem 50
5.2 The Steady State 52
5.3 Around the Steady State 53
6. Lucas's "Optimal Investment with Rational Expectations" 55
7. Keynes's "Marginal Efficiency of Capital" 59
8. Jorgenson's "Neoclassical Investment Demand" 63
9. Kydland and Prescott's "Time to Build" 66
10. Arrow's "Irreversibility of Investment" 67
1l. Conclusions 70
Chapter II Ageing of the Capital Stock: A Long Run Side-Effect of 71
Expansive Fiscal Policy
l. Introduction 73
2. The Model of the Firm 77
2.1 Production Function 77
2.2 Adjustment Costs Functions 79
2.3 State Transition Equation for K(t) 80
2.4 State Transition Equation for E(t) 80
2.5 Objective Functional 81
