Table Of ContentInvesting Today for the World
of Tomorrow
Springer-Verlag Berlin Heidelberg GmbH
Deutsche Bundesbank (Editor)
Investing Today
for the World
of Tomorrow
Studies on the Investment Process
in Europe
With 40 Figures and 55 Tables
Springer
Editor
Deutsche Bundesbank
Wilhelm-Epstein-StraBe 14
60431 Frankfurt
Germany
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lnvesting today for the world of tomorrow: [studies on the investment process
in Europe]; with 55 tables / Deutsche Bundesbank (ed.). - Berlin; Heidelberg;
New York; Barcelona; Hong Kong; London; Milan; Paris; Singapore; Tokyo:
Springer, 2001
ISBN 978-3-642-62523-7 ISBN 978-3-642-56601-1 (eBook)
DOI 10.1007/978-3-642-56601-1
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Contents
Investing Today fortheWorld ofTomorrow - aSummary
HeinzHerrmann 1
1 Tax Policy and Capital Formation under the EMU: Perspectives on German
Economic Policy
RobertS. Chirinko 9
Discussion
AlanJ.Auerbach 38
Discussion
PierluigiCiocca 43
2 InvestmentandTaxationinGermany- Evidence fromFirmLevel PanelData
DietmarHarhoffandFred Ramb 47
Discussion
BronwynH. Hall 74
Discussion
ElmarStoss 79
3 Infrastructure Investment and Economic Activity: Theoretical Issues and
InternationalEvidence
HelmutSeitz 85
Discussion
Juha Tarkka 125
4 Uncertainty andFirmLevel Investment inWest Germany
HjalmarBohm, Michael Funke andNicolausA.Siegfried 131
Discussion
AndrewJ.HughesHallett 152
Discussion
WernerRoeger 162
VI Contents
5 Capital-Market Imperfections, Investment, and the Monetary Transmission
Mechanism
R.Glenn Hubbard 165
Discussion
Vitor Gaspar 195
Discussion
Jiirgen vonHagen 197
6 CorporateGovernanceand theFinancing ofInvestment forStructural Change
Martin Hellwig 201
Discussion
ColinMayer 221
Discussion
Georg Rich 225
7 Firm Level Investment and R&D in France and the United States: A Com
parison
BenoitMulkay, Bronwyn H.Hall andJacques Mairesse 229
Discussion
Julie Ann Elston 274
Discussion
Stacey Tevlin 279
8 InterpretingDevelopedCountries'Foreign Direct Investment
RobertE. Lipsey 285
Discussion
Michael P.Devereux 326
Discussion
John Hawkins 331
Notes onContributors 337
Investing Today for the World of Tomorrow - a
Summary
Heinz Herrmann
On April 28 and 29, 2000, the Bundesbank hosted its second spring conference
entitled 'Investingtodayfortheworldoftomorrow'.
Investment is the key to the development of a nation's economy. In the short
term, investment often leaves its mark on a country's cyclical situation. Over the
longer term, investment is significant because the amount and structure of
investment plays a decisive role in a country's outlook for growth. It is therefore
important to understand the driving forces behind, and potential barriers to, the
capital-formationprocess.
Investment decisions hinge on a number of factors. The intention of this
conference, which brought together economists from academe and economic
policy institutions, was to shed light onthose factors that are either influenced or
even determined byeconomic policy makers.Animportantagentinthiscontext is
the state, which taxes income derived from investment, grants subsidies and also
creates a framework by making investments of its own. A number of chapters in
thisvolumearethereforedevoted tothoseaspects.
A second field that is important to investment is occupied by financial factors,
which are undoubtedly of particular interest to central banks. It is true that the in
many cases somewhat mechanistic ideas of the past, which held that monetary
policy makers could use the interest-rate elasticity of investment demand to sim
ply dictate economic events, are passe. However, therecan be little doubt that the
conditions whichmonetarypolicy makersareaimingtoachieve, betheyregarding
the interest born by invested funds, the willingness of credit institutions to grant
loans, or future inflation expectations, are all relevant to the capital-formation
process. Today the financial framework is seen in a more comprehensive light
than in the past. Institutional features of financial systems are being addressed in
more detail. Against the background of variegated financial systems in different
countries and thechanges takingplace inthatfield,itisonlylogicaltoinquireinto
the interdependence between the investment process and the financial system. In
thisvolume,variousarticlesaddress suchaspects.
The first chapter, 'Tax policy and capital formation under the EMU: Per
spectives on German economic policy' by Robert Chirinko, raises a series of
important questions in connection with the investment process in general and in
Germany in particular. Chirinko develops a framework which enables us to find
2 InvestingToday fortheWorld ofTomorrow- aSummary
answers to those questions or at least to discuss them in a consistent manner.
Some of the basic questions are: How can wetell whetherthe capital stock in an
economy is sufficient? Through what channels does tax policy affect capital for
mation and growth? What is Germany's situation at the beginning of monetary
union? And howshould theguidelines oftheplanned taxreform of2001 beclassi
fied? Given that it is intended (and probably makes sense from an economic
standpoint) to accelerate capital formation, Chirinko goes into the probable im
pacts of the planned business income tax cut, the abolition of capital gains taxes
and the increase in energy taxes. Finally, Chirinko also analyses the significance
for investment activity of the liberalisation of labour markets whichis often being
called for. True, clear and unambiguous answers to thosequestions do notalways
exist. However, the important thing is that the analysis makes it possible to clas
sify the various arguments and enable a consistent debate. Later chapters go into
furtherdetail onaseriesofhisargumentsandquestions.
Alan Auerbach largely agrees with Chirinko's analysis, but at the same time
indicates some additional points thatshould betakenintogreater account infuture
debates on the investment process.They include the distinct shift of the spectrum
from traditional investment goods to investment goods in the IT sector, which
might have consequences, inter alia, for the relationship between capital and la
bour; furthermore, hefeels that more careful studyshould be givento theimplica
tions of the globalisation of the financial markets, whichare likely topromote the
investment process thanks to the improved possibilities for optimally allocating
risks, and finally also to theconsequences oftheageingpopulation for the signifi
cance of a sufficient capital stock. Perluigi Ciocca, too, largely agrees withChir
inko's analysis. Against the background of problems of high unemployment and
low growth that afflict Europe, he discusses, in particular, the choice of taxing
capital or labour income more heavily. In that context he also discusses a better
coordination of tax systems inEurope, whichhe feels would bedesirable so as to
avoidproblems thatcould develop becausecapital ismoremobilethanlabour.
In neo-classical investment theory, the user cost of capital is a fundamental
element of the investment process. In empirical terms, though, its influence is
much more controversial. It is not uncommon that in past studies the empirical
influence of this variable has been shown to be either minor or entirely insignifi
cant. In the second chapter, 'Investment and taxation in Germany - Evidence
from firm level panel data', Dietmar Harhojfand Fred Ramb use a comprehen
sive set of data to examine how investmentreacts to changes in user costs inGer
many and study their relevance to Germanenterprises. In a second step, they then
analyse how past andplanned reforms incorporate taxationhavechanged andwill
change investment behaviour. Such studies havehitherto notexisted forGermany.
Harhoffand Ramb uncover asignificant influenceofusercostsoninvestment; the
elasticity, at -0.5, is somewhere in the middle range of corresponding American
studies. With respect to tax reforms, theyconclude that the 1999 tax cut reduced
user costs, thus promoting investment. The coming 2001 tax reform, though, will
Heinz Herrmann 3
tend to have the opposite effect, according to their estimates. However, the im
pacts could vary quite sharply from one enterprise to another, depending on how
much they are affected by the planned changes to the depreciation options, which
willbecome lessfavourable.
In her commentary, Bronwyn Hall devotes particular attention to some
methodological problems in Harhoffand Ramb's paper which are typical of such
studies. She begins by reiterating the advantages of studies using firm-specific
data. Then she continues by pointing out the special problems and solution
approaches in the use of error correction models compared to distributed lag
models insuch studies. At theend she draws attention tosome pitfalls that need to
be taken into account if one wishes to derive the consequences of a change in the
tax system for the cost of capital. ElmarStoss also warns of the dangers of being
too hasty in incorporating the empirical findings regarding the interest-rate
sensitivity of investments into macroeconomic variables, pointing out that the
company sample used here particularly contains small enterprises. In addition he
states that it would make sense to draw a distinction between investment for
construction andinvestmentonmachinery intheempirical approaches.
The first two chapters of this book analyse, in particular, the role played by the
government in the process of private investment via the tax system. Yet the gov
ernment also influences the capital stock by itself acting as an investor. By means
of infrastructural measures, for instance, it can improve conditions for private
investors; furthermore, it may act as a competitor to private investors,and finally,
the burden on the private sector posed by the financing of those investments also
plays a role. In the chapter titled 'Infrastructure investments and economic
activity: theoretical issues and international evidence', Helmut Seitz presents a
whole range of aspects of government investment. In the theoretical section, Seitz
introduces various production and profit-oriented approaches whichcan beused to
study the impact of public investment on macroeconomic development. He also
points out that the positive effects of investment on output must be weighed
against their costs, an argument that has often been neglected in the past. In the
empirical section, Seitz briefly comments on the situation in eastern Germany
since reunification and then devotes particular attention to the question as to how
public investment in the GEeD countries has changed the demand for labour and
capital. Whereas his studies show that private demand for capital goods reacts
positively to infrastructural measures, they observe no such effect for the demand
for labour. According to Seitz, infrastructural measures can only be expected to
have an indirect positive impact on employment over the long term through
growth effects, ifatall.
In his commentary (not published in this volume), Roberto Perotti iseven more
sceptical than Seitz as to the advantageousness of public investment. He provides
information indicating that whenever a cost-benefit analysis of public investment
is made, Seitz tends to err infavour of infrastructural measures. Moreover, Perotti
4 InvestingToday fortheWorld ofTomorrow- aSummary
draws attention to studies that use another approach to conclude that government
investment impedes private capital formation.Juha Tarkka, firstly,drawsattention
to a number of fundamental points which emerge if the productivity of govern
ment investment is measured and an international comparison is made. (What do
we learn about the underlying political decision-making process? Are wejustified
inconcentrating on the impact ofthis investmenton productivity? Does anaggre
gate analysis make sense ifthere is a substantial divergence inthe productivity of
the government projects because market rate does not determine selection?) Sec
ondly, he compares the empirical results with other estimates which postulate a
higher rateofproductivity asaresultofgovernmentinvestment.
In the following chapter, 'Uncertainty and firm level investment in West
Germany', Hjalmar Biihm, Michael Funke and Nikolaus Siegfried address an
other factor that influences the investmentprocess.Overthe lastfewyearsanum
ber of theoretical studies have asked what impact uncertainty about the future
profitability ofan investment hasontheincentive toinvesttherequisite amountof
capital goods.Investment theory does not provide a clear answer to this question.
On the one hand, increased uncertainty may give rise to future opportunities, and
therefore a positive impact on willingness to invest is conceivable. On the other
hand, though, uncertainty may also be considered as having a negative impact on
investment, if emphasis is placed on the risk of investments not yielding future
profits. This would make it seem wise for the investor to assume a wait-and-see
attitude. The unclear stance of economic theory makes empirical studies of the
effects of uncertainty even more desirable. The authors, after studying data on
large firms in Germany listed on the stock exchange, conclude that increased un
certainty has tended to have a positive impact on their investment. However, a
distinction must be made between various sectors of industry:in strongly concen
trated markets, where individual firms may be assumed to have greater market
power, a negative uncertainty-investment linkseemsquiteconceivable,inadevia
tion from the overall picture.This empirical outcome basically matchesthetheory
thatsuggests aninherentlinkbetweenuncertaintyeffectsandmarketpower.
In his commentary, Andrew Hughes-Hallett reiterated how complex the link be
tween investment and uncertainty is in theory.Not only thedegree ofcompetition
plays arole, but manyotherfactors too,asthetypeofuncertaintyorthecharacter
istics of the industries under consideration (entry costs, scrapping prices etc.).
Against this background he expects reliable estimates ofthe impact of uncertainty
only if wecontrol for manyother variables.Werner Rogerpoints out thatone has
to be careful when interpreting the positive relationship between investment and
uncertainty. This positive association may well be the result of an involuntary
overinvestment in the case of high degree of uncertainty and irreversibility. In
addition, heraises thequestion whethertheempirical results are notmisleadingas
the measures of uncertainty and market power, used by the authors, may reflect
otherfactors thanthose intended.
