Behavior of Business Investment in the USA Under Variable and Proportional Rates of Replacement

Abstract

Using data from the U. S. Bureau of Economic Analysis for the period 1947-2015, we test two investment models of neoclassical decent. Model A is based on the conceptualization that business firms have an active replacement investment policy, which renders the replacement rate a determinant of business investment behavior, whereas Model B is based on the traditional hypothesis that replacement investment is an engineering proportion of the capital stock, thus turning into a constant. The evidence that emerges from the estimations is heavily in favor of Model A on at least three grounds. Namely, first it establishes that the replacement rate is a decisive determinant of investment at all levels of aggregation; Second, it leads to estimates of investment equations with succinct short run and long run dynamics, thus facilitating policy applications; and thirdly, it gives rise to remarkably robust estimates of the elasticities of substitution of capital for labor, output and the replacement rate. When Model B is estimated for the period 1947-1960, it performs as expected, most likely because in short periods remains fairly constant due to long swings in replacement investment.

Keywords: Neoclassical Models of Business Investment, Elasticities of Substitution and Output, Modes of Replacement Investment

JEL Classification: E22, E52, E62