The long- and short-term factors affecting investment in Israel's business sector, 1968-2008

18/03/2010 |  Lavi Yaacov, Menashe Yigal
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This study finds a long-term relation between the level of investment in the business sector, GDP, and the cost of capital that is consistent with the neo-classical theory. The main variable among the cost of capital variables that is negatively related to business sector investment is the relative price of the investment (relative to the price of business sector product). This price reflects technological advances from abroad that improve the quality of capital stock in general and equipment in particular, as well as the real exchange rate in terms of imports.
Variables related directly to monetary and fiscal policy, such as the short-term post factum real interest rate and the statutory tax rate of all direct taxes, were found to have a negative effect on long-term investment, as expected, and they have different effects on different types of asset (equipment and buildings). The elasticity of foreign direct investment (FDI) to business sector investment is positive but relatively small (about 5.5 percent). Thus, a real increase of NIS 1 billion in FDI would increase business sector investment by about NIS 250 million.
In the short term the rates of change of business sector investment is positively correlated with changes in the level of activity, equipment utilization (obtained from the Bank of Israel Companies Survey), and changes in FDI, and negatively correlated with changes in variables connected with the cost of capital (e.g., the relative price of the investment and the statutory tax rate). In addition, the authors found a negative significant effect on investment of uncertainty resulting from a change in business sector product and in the terms of trade.
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