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Business investment, the user cost of capital and firm heterogeneity

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  • Alari Paulus

Abstract

The sensitivity of business fixed investment to one of its key determinants, the user cost of capital, has been little investigated with firm-level data that captures firm heterogeneity to the full extent. I study the determinants of business fixed investment in Estonia, using the universe of business statements for non-financial firms in 1994-2020 from administrative records. The results with various panel data models provide strong support for a theoretical long-term relationship between the gross investment rate, and changes in production output and the user cost of capital. I find that the capital stock is modestly responsive to changes in output and the user cost of capital, with elasticities less than 0.5 in absolute size, and that different estimation strategies yield broadly similar results. Elasticities differ by firm size, but sectoral variation is relatively limited. User cost elasticities also exhibit notable variation over time, while output elasticities are much more stable. I also find that investments in machinery and equipment are more elastic than investments in buildings and structures.

Suggested Citation

  • Alari Paulus, 2022. "Business investment, the user cost of capital and firm heterogeneity," Bank of Estonia Working Papers wp2022-2, Bank of Estonia, revised 24 Mar 2022.
    • Handle: RePEc:eea:boewps:wp2022-2
    DOI: 10.23656/25045520/022022/0192
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    More about this item

    Keywords

    business investment; user cost of capital; corporate taxation; firm panel data;
    All these keywords.

    JEL classification:

    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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