This paper analyzes in the context of a dynamic model, how firms decide on capital investment if the accompanying adjustment costs are a function of the governmental activity. The government provides the public input and decides on the degree of rivalry. The productive public input enhances private capital productivity and reduces the adjustment costs. An equilibrium in which capital and investment ratio are both constant is derived; comparative dynamic analysis is carried out; and policy implications of the model are discussed. Increasing the amount of the public input unequivocally spurs the capital investment, whereas the result becomes ambiguous with respect to the impact of rivalry. Since a reduction in congestion increases the individually available amount of public input, crowding out effects may lead to a reduction in the equilibrium capital stock. Although most of the analysis is conducted in the context of general production functions, the case of Constant Elasticity of Substitution (CES) production function is exclusively considered.
The impact of the governmental activity on the investment of firms has extensively
been studied in the last several years. Beginning with the seminal work of Aschauer
(1989a, 1989b); Barro (1990) more recent models analyze the impact of governmental
inputs on capital productivity and include aspects of congestion, uncertainty, or
excludability (Fisher and Turnovsky, 1998; Turnovsky, 1999a, 1999b; Turnovsky,
2000a; Ott and Turnovsky, 2006). Within these models governmental activity consists
of two parts: first, the provision of a productive input and second, the choice of the
corresponding financing scheme. The latter is required to provide a certain amount of
public input and internalize the external effects of capital accumulation that arise in
case of congestion. While simple models assume that the output might be transferred
into private capital without incurring additional costs, the literature on investment
theory, which derives from the ‘Tobin’s q’ theory, focuses on the impact of adjustment costs. A survey of relevant approaches is given by Hamermesh and Pfann (1996); and
Cooper and Haltiwanger (2006). Recent empirical studies can be found in Hall (2004),
whereas an industry-specific discussion is done by Caballero and Engel (1999).
Following the seminal work of Hayashi (1982), most authors who focus on capital
adjustment costs, model them as ratio of investment in each period and the firm’s
capital stock. An exception is Turnovsky (1996), who in his paper has developed a
one-sector endogenous growth model in which capital investment involves adjustment
costs that are related to governmental activity. Holtz-Eakin and Lovely (1996), also
highlight the cost reducing effect of governmentally provided infrastructure. This
perks up the argument that firm specific aspects are not the unique determinants of
capital adjustment. Apart from them the economic environment also gains importance.
With respect to this argument, the governmental activity also includes non-fiscal
instruments, such as implementation of legislation which defines a firm’s institutional
environment (North, 1990; Knack and Keefer, 1995; or more recently Acemoglu et al .,
2001, 2005; as well as Eicher and Garcia-Penalosa, 2006). To sum up, public policy
plays an important role in the firm’s capital investment decision via several channels. |
