Investment Theories and Analysis

Investment Theories and Analysis

Also by M. C. Baddeley WHAT GLOBAL ECONOMIC CRISIS? (edited with Philip Arestis and John McCombie)

lnvest1ent Theories and Analysis M.C. Baddeley Gonville and Caius College Cambridge Foreword by G.C. Harcourt

* M.C. Baddeley 2003 Foreword G.C. Harcourt 2003 Softcover reprint of the hardcover 1st edition 2003 978-0-333-91569-1 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted her right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2003 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin's Press, LLC and of Palgrave Macmillan Ltd. Macmillan is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 978-0-333-91569-1 hardback ISBN 978-0-333-91570-7 ISBN 978-1-4039-1864-2 (ebook) DOI 10.1007/978-1-4039-1864-2 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Baddeley, Michelle, 1965- lnvestment : theories & analysis I Michelle Baddeley. p. cm. Includes bibliographical references and index. ISBN 978-0-333-91569-1 (cloth) - ISBN 978-0-333-91570-7(pbk.) 1. Investments. I. Title: Investment: theories and analysis. II. Title. HG4521.B3428 2003 339.4'3-dc21 2002191249 10 9 8 7 6 5 4 3 2 1 12 11 10 09 08 07 06 05 04 03

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Contents List of Boxes, Tables and Figures List of Abbrwiations Foreword by G. C. Harcourt Acknowledgements ix xi xii xiv Part I Overview 1 Introduction 2 An overview of concepts and approaches Part II Theoretical Issues 3 Intellectual ancestors: Irving Fisher and Maynard Keynes 4 Accelerator theory 5 Jorgenson's model of investment 6 The limitations of Jorgenson's model 7 Putty-clay models of investment 8 Adjnstment costs and q theory 9 Uncertainty and investment 10 Post Keynesian analyses of investment Part ill Testing the Theories 11 Comparing Jorgenson's model and accelerator theory: evidence from the UK 12 Uncertainty in competing models of investment: evidence from the USA Part IV Empirical Applications of Investment Principles 13 Computing investment in the New Economy: US evidence 14 Investment and development: a cross-sectional analysis vii 3 8 23 47 57 66 79 92 109 124 139 149 163 181

viii 15 Residential investment: bubbles and crashes in the UK housing market, 1980-99 Part V Conclusion 16 Concluding remarks Notes Glossary Statistical appendix: some basic econometric techniques Bibliography Index Contents 193 211 217 221 227 235 249

List of Boxes, Tables and Figures Boxes 2.1 2.2 3.1 3.2 3.3 3.4 4.1 4.2 5.1 5.2 6.1 8.1 9.1 14.1 Types of investment Present value, internal rate of return and discount rates Fisher's rate of return over costs and net present value A brief biography of Irving Fisher The marginal efficiency of capital A brief biography of John Maynard Keynes Simple accelerator theory Flexible accelerator models Jorgenson's model The output and user cost elasticities in Jorgenson's model Expectations and uncertainty in models of investment Adjustment cost models Applying real options principles in practice Empirical convergence models 9 11 27 29 31 31 so 52 60 62 71 98 116 187 Tables 11. l Results from the estimation of accelerator models 143 11.2 Results from the estimation of neo-classical models 144 11.3 Non-nested test results, p values 145 11.4 Results from the estimation of the hybrid model 146 12.l Parameter estimates fur q models without uncertainty 154 12.2 Parameter estimates fur q models with uncertainty 155 12.3 Keynesian-Kaleckian models 156 12.4 Non-nested tests, p values 157 13.1 An estimation of computing investment in the USA 176 14.l Absolute fj convergence models 188 14.2 Absolute gap convergence models 188 14.3 Conditional fj convergence models 189 14.4 Conditional gap covergence models - restricted versions 189 15.l Owner occupation rates in the OECD, 1998 198 ix

x List of Boxes, Tables and Figures 15.2 Policy changes affecting the housing market 15.3 Minskian bubble-crash models 15.4 Demand augmented bubble-crash models 15.5 Neo-classical models incorporating the user cost of housing investment 15.6 Non-nested test results, p values 199 202 203 205 206 Figures 2.1 3.1 7.1 7.2 8.1 13.l 13.2 13.3 13.4 14.1 14.2 Replacement investment Keynes's investment demand schedule Capital and labour as substitutes in putty models Capital and labour as complements in clay models Adjustment costs and investment Growth in transistor count, logarithmic scale Computing investment as a proportion of total investment Average age of selected fixed assets, USA, 1978-2000 US venture capital disbursements to computer hardware, communications and the Internet Growth in investment, 1988-98 Standard deviation of investment rates, 1988-98 10 33 82 83 95 165 166 171 175 185 186

List of Abbreviations ADF AMEX BEA BLUE CAPM DC DF FIRE GDP GLS IT LDC MIRAS n/a NASDAQ NDP NPV NYSE OLS ONS R&D REH UN Augmented Dickey Fuller test American Stock Exchange US Bureau of Economic Analysis Best Linear Unbiased Estimator Capital Asset Pricing Model Developed country Dickey Fuller test Financial, insurance and real estate sector Gross domestic product Generalized least squares Information technology Less developed country Mortgage interest relief at source Not applicable US National Association of Securities Dealers Net domestic product Net present value New York Stock Exchange Ordinary least squares UK Office of National Statistics Research and development Rational Expectations Hypothesis United Nations xi

Foreword Michelle Baddeley' book, which started life as her PhD dissertation at Cambridge (I had the privilege of supervising her/it), exemplifies the best sort of relevant applied research. As the author rightly emphasizes, investment in physical assets, accumulation as our classical pioneers and Marx had it, is the concept most critical to our understanding of the processes at work over time in capitalist economies, ancient and modem. With this as the central focus, Dr Baddeley provides clear and comprehensive accounts of the principal rival theories of investment behaviour in the modern era. She starts with the theories of two modern giants, Irving Fisher and Maynard Keynes, from which virtually all subsequent developments derive - Dale Jorgenson's writings from the 1960s on, the various versions of accelerator (capital-stock-adjustment) theories, James Tobin's q, Avinash Dixit and Robert Pindyck's influential contribution, their real options theory, for example. (Dr Baddeley also gives Michal Kalecki rightful due for his independently derived and highly original theories of accumulation.) Not only does she provide a deep understanding of the issues and approaches iovolved, she is also a sympathetic and, where necessary, tough critic. With her astute and acute gaze no emperor is likely to get away with nakedness. As is to be expected of an all-round economist, Dr Baddeley follows up her illuminating theoretical discussions with a number of thorough empirical studies. She uses econometric techniques as they should be used, to illuminate, to compare the respective merits of rival theories, while always keeping in mind the techniques' proper domain and limitations. There are cross-section and time-series studies, including a fascinating study of the UK residential market. Dr Baddeley's conjecture has always been that Keynes and Kalecki were closer to a proper understanding of accumulation than were the neo-classicals, Fisher (great economist though he was), Jorgenson and even the late James Tobin, an eminent Keynesian economist (and superb human being) who, nevertheless, in his q theory drew on two, I have to say, incompatible xii

Foreword xiii approaches. From the evidence she so carefully presents, her conjecture is confirmed. I recommend In11estment: Theories and Analysis as a model of what applied economic research should be, and I now ask readers to read on and judge for themselves. My conjecture is that they will not be disappointed. Jesus College, Cambridge April 2002 G.C. HARcoURT xiii

Acknowledgements I would like to thank Geoff Harcourt for his help and advice as my PhD supervisor, for further advice and encouragement in more recent years, for commenting on drafts of this book, and for writing the Foreword. I would also like to thank Philip Arestis for encouraging me to write this book; my PhD examiners, Malcolm Sawyer and Kevin Lee, for their comments, many of which have been incorporated into the book; and the anonymous reviewers of this book for their comments and advice on a preliminary draft. My gratitude also goes to Rachel Wood for her careful yet enthusiastic proof-reading. Of course, all errors or omissions are my own. I would also like to thank my commissioning editor, Ursula Gavin, and copy-editor, Keith Povey, for their patient support. For general advice and encouragement I thank my friends and family, especially my parents. MICHELLE BADDELEY xiv