Increases in Business Investment Rates in OECD Countries in the 1990s: How Much Can Be Explained by Fundamentals?

OECD Economics Department Working Paper No. 327

40 Pages Posted: 4 May 2002

See all articles by Florian Pelgrin

Florian Pelgrin

Bank of Canada - Department of Monetary and Financial Analysis

Sebastian Schich

Organisation for Economic Co-operation and Development (OECD)

Alain de Serres

Organization for Economic Co-Operation and Development (OECD) - Economics Department (ECO)

Date Written: April 2002

Abstract

In several OECD countries, investment rates in the business sector grew strongly in the second half of the 1990s. In some cases, the strength of private investment relative to output growth had raised concerns about the risk of capital overhang and the prospect of a prolonged period of slow capital formation in order to bring investment levels back to more sustainable levels. It is possible that the stock market boom has contributed to a rise of investment demand to an excessive level, not only in the United States, but also in the United Kingdom, Canada, Scandinavia and Greece. The purpose of this paper is to assess the contribution of fundamental determinants to the change in investment in the second half of the 1990s, based on the estimation of panel cointegration equations for gross business investment for 18 OECD countries from 1970 to 1999. In addition to the levels of real GDP and a measure of the cost of capital, the set of explanatory variables includes four alternative proxies for financial market development. The inclusion of the latter variables helps to identify a coefficient for output that is close to one as well as a coefficient for the cost of capital that is both negative and significant. Based on these estimation results, the rise in the volume of business investment observed in a number of countries during the second half of the 1990s can only be partly explained by the set of basic determinants. On that basis, the empirical analysis would tend to support the view that investment had exceeded its steady-state level, not least in the United States. However, as suggested by the recent pick-up in investment, the size of the capital overhang in the United States might turn out to be smaller than feared, especially once the increases in trend output growth and depreciation rates are taken into account.

Keywords: Financial development, investment, non-stationary panels

JEL Classification: O16, E22, C33

Suggested Citation

Pelgrin, Florian and Schich, Sebastian and de Serres, Alain, Increases in Business Investment Rates in OECD Countries in the 1990s: How Much Can Be Explained by Fundamentals? (April 2002). OECD Economics Department Working Paper No. 327, Available at SSRN: https://ssrn.com/abstract=307760 or http://dx.doi.org/10.2139/ssrn.307760

Florian Pelgrin

Bank of Canada - Department of Monetary and Financial Analysis ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
613-782-8667 (Phone)
613-782-7713 (Fax)

Sebastian Schich

Organisation for Economic Co-operation and Development (OECD) ( email )

2 rue Andre Pascal
Paris Cedex 16, MO 63108
France
+33 1 4524 1419 (Phone)
+33 1 4524 9050 (Fax)

Alain De Serres (Contact Author)

Organization for Economic Co-Operation and Development (OECD) - Economics Department (ECO) ( email )

2 rue Andre Pascal
Paris Cedex 16, MO 63108
France

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