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Oxford Economic Papers Advance Access originally published online on August 20, 2004
Oxford Economic Papers 2005 57(1):120-141; doi:10.1093/oep/gpi001
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© Oxford University Press 2004; All rights reserved

Profitability, capacity, and uncertainty: a model of UK manufacturing investment

Ciaran Driver*, Paul Temple{dagger}, and Giovanni Urga{ddagger}

*Tanaka Business School, Imperial College, University of London, London SW7 2AZ; email: c.driver{at}imperial.ac.uk {dagger}Department of Economics, University of Surrey, Guildford, Surrey GU2 7XH; email: p.temple{at}surrey.ac.uk {ddagger}Cass Business School, Faculty of Finance, 106 Bunhill Row, London EC1Y 8TZ; email: g.urga{at}city.ac.uk

Standard models fail to explain variation in UK capital investment. This paper develops and tests a new theory based on the insights of Edmond Malinvaud, in which investment under uncertainty is adjusted to balance the cost of excess and deficient capacity. Using quarterly UK manufacturing data on two capital assets (machinery and building) over a 30-year period, we obtain unique cointegrating relationships for the model, linking investment, profitability and capacity utilization. Non-nested testing shows that the estimated model performs similarly to a frequently used survey of investment intentions. Our model also addresses differences in the behaviour of the two asset classes; we show that building investment fell relative to machinery investment over the period, reflecting not only relative prices and profitability, but also long term influences such as technology or governance. At the macro level we find little role for any effects from taxation or financial constraints.

Key Words: JEL classification: D80 • E22 • L60 • C22


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