Chapter VI: Capital, Investment, and International Capital
Download
Report
Transcript Chapter VI: Capital, Investment, and International Capital
Chapter VI: Capital, Investment,
and International Capital Flows
A.
B.
C.
D.
The determinants of savings
The investment decision
Marginal product of capital and user
costs of capital
Capital flows in the global economy
Cases: The U.S. and LDCs
Goethe Business School
The capital market
Households
receive income,
consume and save:
Buy debt and equity
1. Firms
issue debt, equity
2. Governments
issue debt
Savings
Investment
Capital Market
2
Goethe Business School
Again: I = S
The capital clears in a closed economy
if S = I
Savings can be decomposed into
household and government savings
Household savings is SP = Y - T - C
Government savings is SG = T - G
We obtain
SP + SG = I
3
Goethe Business School
Determinants of savings
Savings depends on
The level of income
The interest rate
Government policies
r
S
4
Goethe Business School
Shifts in the S-curve
If income increases,
the S-curve shifts to
the right
r
If government outlays
increase, the S-curve
shifts to the left
r
S
S
5
Goethe Business School
“Crowding out”
In a closed economy, government could
“crowd out” private investors
It means increasing public spending,
i.e. reducing government saving
It will increase the market interest rate
r
S2
S1
r2
r1
I
I, S
6
Goethe Business School
Crowding out and the
Maastricht “Stability Pact”
The fact that governments can “crowd out”
other participants of the capital market caused
concern when the new European currency was
created
In order to control this effect,
the EU member states have adopted
the so-called “Maastricht budget criteria”:
Level of government debt < 60% of GDP
Annual budget deficit < 3% of GDP
7
Goethe Business School
The Maastricht budget criteria
The purpose is to limit the impact
of government borrowing on interest
rates
France, Germany, Italy and other
eurozone countries are persistently
violating the deficit criterion
Violation of the criteria may entail
sanctions (fines)
8
Goethe Business School
The market for EMU
government bonds
9
Goethe Business School
Impact of “crowding out”
It is obvious that the impact of “crowding
out” is greatest for the largest countries,
not for smaller countries such as Portugal
and Greece
But interestingly, it is exactly in the larger
countries where the complaints about
“too high real interest rates” are loudest
10
Goethe Business School
Fiscal positions (1)
11
Goethe Business School
Fiscal positions (2)
Goethe Business School
Reading
Abel, Bernanke and Croushore,
Chapter 4.1
(without Applications)
13
Goethe Business School
The stock of capital
Investments consist of the purchase or
construction of capital goods, including
residential and nonresidential buildings,
equipment and software used in production,
and additions to the inventory stock
The capital stock develops in line with
investment in the following way:
Kt = Kt-1 (1 - d) + It
14
Goethe Business School
Net investment
The usage of capital requires the firm to
replace existing capital (d Kt-1)
This part of investment is called
“replacement investment” (or depreciation)
The difference between gross investment
and replacement investment is called
“net investment”
Only net investment will expand the capital
stock
15
Goethe Business School
Investment and
the production cycle
Percentage increase p.a.
4,0
Contribution of
investments
Growth of
World GDP
3,7
3,0
3,1
3,0
2005
2006
2,6
2,1
1,8
1,4
Other contributions
1998
1999
2000
2001
2002
2003
2004
Source: Worldbank
16
Goethe Business School
The investment decision
A firm expands its capital stock only
if it expects some profit from it
More precisely: the investment is
expected to generate a resource flow that
covers at least current costs
(wages, material, energy), plus a residual
This residual is the return on investment
17
Goethe Business School
Neoclassical
investment theory
The neoclassical theory of
investment has benefited
from the work of Dale W.
Jorgenson (Harvard)
It is useful when making
decisions on the purchase
of equipment
Dale W. Jorgenson
* 1933
18
Goethe Business School
Two types of firms
We consider two types of firms:
Producers. They use capital goods
which they rent from leasing firms
Leasing firms. They demand investment
goods and lease them
to producers
Producers pay a rental price for using
the capital good
19
Goethe Business School
Marginal product and
rental price of capital
The return on investment of the firm is
equal to the marginal product of capital
(MPK) times the price of its final product
R = P MPK = P [F(L,K) / K]
or R/P = MPK
The rental price of the capital good cannot
be higher than the real return on
investment, or the producer makes a loss
20
Goethe Business School
Expected MPK
The marginal product
of capital
MPK
Capital stock
21
Goethe Business School
The user costs of capital
Now we ask which costs the leasing firm
will have to bear (user costs of capital =
Ucc ) when purchasing a capital good at
the price of PK
There are three types of costs:
Opportunity costs of financing i PK ;
Depreciation d PK ;
Capital losses (and gains) - PK.
22
Goethe Business School
User costs of capital
Ucc = i PK + d PK - PK
= PK (i + d - PK / PK )
The user costs of capital are the higher,
The higher the interest rate i ;
The higher the depreciation rate d ;
And the higher the risk of falling prices of the
asset, and the dimension of the price change
23
Goethe Business School
Fisher-Gleichung
We assume that PK / PK
changes with the general rate
of inflation
Furthermore the following
relationship between real
and nominal interest rates holds
(Fisher equation):
i=r+
It eliminates the need
to consider capital losses
Irving Fisher
1867-1947
24
Goethe Business School
Determining the desired
capital stock
We now consider the profit per unit of capital in
order to determine the desired capital stock
Unit profit = Unit return (gross) - unit costs
= P MPK - PK ( r + d )
The change of the capital stock
(net investment) depends on unit profits
As long as unit profits are positive, there will by
net investment, and the capital stock grows
25
Goethe Business School
Investment function
Net investment is therefore:
K = I net = Inet [MPK - PK/P (r + d)]
And including replacement investment
we obtain
I gross = Inet [MPK - PK /P (r + d)] + K
26
Goethe Business School
Expected MPK, and Ucc
The desired capital stock
Ucc
MPK
K*
Capital stock
27
Goethe Business School
Expected MPK, and Ucc
Changes in the desired
capital stock (1)
A lowering of the real interest rate
will decrease Ucc and encourage
net investment to expand the desired
capital stock
Ucc1
Ucc2
MPK
K1* K2*
Capital stock
28
Goethe Business School
User cost of capital in the
global economy
The user costs of capital also depend
on taxes and other capital charges
In a competitive international environment,
the net-of-tax profit rate determines
investment
International capital flows are driven by
“tax competition” among governments
29
Goethe Business School
User cost of capital
and taxes
The real interest rate is just one
component of Ucc, and it should be rather
uniform within the euro area
If countries have negative net foreign
investment this is likely to reflect other
components of Ucc, including taxes
Ucc drives the mobility of fresh capital
Once installed, fixed capital is usually
“locked in”, at least for some time
30
Goethe Business School
Changes in the desired
capital stock (2)
Expected MPK, and Ucc
A technological advance will
increase MPK and encourage
net investment to expand the desired
capital stock
Ucc1
MPK,2
MPK,1
K1*
K2*
Capital stock
31
Goethe Business School
MPK in the global economy
International capital flows are also driven
by evolving differences in MPK
Technical and organizational progress of
an economy and innovation tends to
attract international investments
The MPK curve can also be dragged down
by government interventions, “red tape”,
over-regulation, and market rigidities
32
Goethe Business School
Real interest rate, r
Savings and investment:
equilibrium
Saving, S
E
Investment, I
Desired national saving, and desired investment
33
Goethe Business School
Reading
Abel, Bernanke and Croushore,
Chapter 4
(without Appendix)
34
Goethe Business School
Returning to
the United States
In Chapter 2,
we discussed the size
of the current account
deficit of the United
States
Source: Economist
35
Goethe Business School
US trade (percentages of total)
Year-to-Date 2005 March
Exports
C anada
M exic o
J apan
UK
C hina
G ermany
S outh Korea
N etherlands
Franc e
T aiwan
S ingapore
Belgium
H ong Kong
A us tralia
Brazil
O ther
Imports
2 3 ,6 %
1 3 ,1 %
6 ,1 %
4 ,4 %
4 ,2 %
3 ,9 %
3 ,2 %
3 ,1 %
2 ,7 %
2 ,5 %
2 ,4 %
2 ,1 %
1 ,8 %
1 ,7 %
1 ,6 %
2 3 ,6 %
Source: U.S. Census Bureau
C anada
C hina
M exiko
J apan
G ermany
UK
S outh Korea
T aiwan
Franc e
V enezuela
I taly
M alays ia
I reland
Brazil
S audi A rabia
O ther
1 7 ,7 %
1 3 ,4 %
1 0 ,2 %
8 ,9 %
5 ,2 %
3 ,0 %
2 ,9 %
2 ,2 %
2 ,1 %
2 ,0 %
1 ,9 %
1 ,8 %
1 ,8 %
1 ,5 %
1 ,5 %
2 3 ,9 %
36
Goethe Business School
US Deficit
by major trading partner
U.S. Deficit by Major Countries
Year-to-Date March 2005
UK
Brazil
France
Taiwan
Germany
South Korea
Mex ico
Canada
Japan
China
-50
-40
-30
-20
-10
0
US $ billion
Source: U.S. Census Bureau
37
Goethe Business School
2004 Global current account
($ bill. IMF and Roubini/Setzer)
Main def icit count ries
U SA
A us tralia/N ew Z ealand
U nited Kingdom
E as tern E urope
Main surplus count ries
C anada
A s ia (without Japan)
J apan
O il ex porters
Wes tern E urope (without U K)
A fric a and L atin A meric a
G lobal res idual
-783
-660
-36
-43
-44
783
28
159
154
195
172
12
63
38
Goethe Business School
Global balance?
IMF and Roubini/Setzer
39
Goethe Business School
Current balance and
foreign capital account
A current account deficit or surplus CBt
entails international capital or financial
flows that affect a country’s net foreign
asset position KFt
CBt = KFt
or KFt = KFt-1 + CBt
40
Goethe Business School
The capital and financial
account
International transactions involving assets, either
real or financial, are recorded in the capital and
financial accounts
The sum of the current balance and the capital
and financial account add to zero
(but there is a statistical discrepancy)
Capital flows correspond to changes in net
foreign assets held by residents
(foreign bonds, stocks, real estate, or currency)
41
Goethe Business School
Changes in the net foreign
position of a country
Net foreign assets are part of a country’s
national wealth
The foreign asset position can change in
two ways:
Acquisition of new foreign assets or liabilities
Change in the value of existing foreign assets
and liabilities
Through
asset price changes
Through exchange rate changes
42
Goethe Business School
Flows and stocks
We also saw how the
current account deficit
affected the net wealth
position of the United
States
The question was:
Is this worrisome?
Source: Economist
43
Goethe Business School
Some reflections on the
United States deficit
Although the United States is the largest debtor
of the world, it can more easily bear that debt
than most other countries:
The U.S. economy is strong and growing
The debt/GDP ratio is still comparably small
Foreign debt does not necessarily imply the U.S.
economy to be “controlled” by foreigners
The holdings of U.S. debt by foreigners is partly
voluntary, partly Institutional (central bank reserves)
The relative wealth position can be improved by
depreciating foreign debt via a devaluation of the U.S.
dollar
44
Goethe Business School
Reading
Reading 6-1: Brad Setser et alii,
“How scary is the deficit”, Foreign Affairs, July/August
2005
Reading 6-2: “The American economy: Wise men at
ease”, The Economist, April 28th 2005
Reading 6-3: “Show me the money”, The Economist,
July 7th 2005
45
Goethe Business School
LDCs remain
the largest capital exporter
The current balance of LDCs
Percent
$ billion
Current balance
in percent of GDP
(right axis)
Source: Worldbank
46
Goethe Business School
International saving
and the U.S. deficit
The strengthening of LDCs, in particular
the “emerging economies” in Asia and
Latin America entail higher world savings
These savings may not find low-risk
investment opportunities at home, so they
are channeled to world capital markets
Higher world savings will have to be
absorbed by industrialized countries, and
drive the world real interest rate downward
47
Goethe Business School
Real
interest rate
The world interest rate
and an industrialized country
World
OECD country
S1
S2
r1
r2
I
Foreign
borrowing
48
Goethe Business School
Why can OECD countries
borrow more easily?
Industrialized countries
draw benefits from
Greater political stability and lower risks
High incomes = manageable debt/GDP ratios
A high absorption potential
Well developed financial markets
Comparably stable currencies
Currencies that qualify as international
means of payment and reserves
49
Goethe Business School
Discussion 6:
Capital, Investment, and
International Capital Flows
What determines savings in the economy?
What factors are relevant for investment
decisions?
What does “crowding out” mean?
Can you imagine “crowding out” at a
global scale?
What would be the main instrument to
“crowd out”?
50
Goethe Business School