See discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/4790436 Labour and Financial Market Determinants of Investment Decisions in Europe ARTICLE · FEBRUARY 2003 Source: RePEc CITATIONS 3 READS 12 2 AUTHORS: Giorgio Calcagnini Università degli Studi di Urbino Carlo Bo 50 PUBLICATIONS 149 CITATIONS SEE PROFILE Enrico Saltari Sapienza University of Rome 57 PUBLICATIONS 194 CITATIONS SEE PROFILE Available from: Giorgio Calcagnini Retrieved on: 15 January 2016
European Integration, Financial Systems and Corporate Performance
UNU/INTECH - Maastricht - October 3, 2002
Labour and Financial Market Determinants of Investment Decisions in Europe♥
G. Calcagnini (Università di Urbino) – E. Saltari (Università di Roma “La Sapienza”)
I. Introduction
This paper aims at analysing how labour and financial markets influence investment decisions in
Europe and in the U.S. Traditionally, the relationship between the acquisition of new capital goods
and the labour market, on one hand, and financial markets, on the other, are analysed separately.
Conditions prevailing in the labour market (wage rates, conflicts, etc.) may influence firms’
decisions to invest either by rendering capital relatively more convenient than labour, or by directly
affecting profits. It is statistically more likely that firms will find themselves in the former condition
when profits are low and their financial conditions are not optimal. In a Modigliani-Miller world
(MM henceforth), profitable projects would not be precluded by low levels of internally generated
funds and/or high levels of leverage. Funds would efficiently flow towards all projects with a
positive net present value. Otherwise, investment decisions will face credit or equity rationing when
capital markets show some type of imperfection. Then, financial markets, or their higher or lower
degree of efficiency, will either lessen or reinforce the (dis)incentives to investments originating
♥ This version gratefully benefited from comments and suggestions from V. Fitzgerald, P. Molyneux, PC Padoan and seminar participants at the Market Labour Policy Group, Wellington (NZ). The usual disclaimer applies.
Calcagnini—Saltari Maastricht - October 3, 2002 2
from the labour market. But it is also the case that differences in financial markets’ efficiency may
not be useful in explaining the different paces of capital accumulation across countries, if
differences in national labour markets (the type of bargaining systems, the degree of labour
flexibility, etc.) are not taken into account. Indeed, countries with less efficient financial markets
may possess labour market features that allow firms to promptly adjust to (negative) shocks and
maintain balanced financial conditions. Therefore, a model that includes both labour and financial
market features should represent a better description of investment decisions. Our results from a
sample of twelve countries, and observations for the manufacturing industries over the period 1987-
1999, are favourable towards this new approach and, therefore, to the richer empirical specification
adopted here for the investment function.
The paper is organized as follows. Section II reviews the most recent contributions
concerning a) the effects of the presence of institutions on the labour market and how they interact
with firms’ investment decisions; b) the relationship between financial market imperfections and
investment. Section III addresses the empirical evidence concerning both separate relationships, as
well as the interaction between labour and financial markets on investment. Finally, Section IV
summarizes the main results of the paper and discusses their policy implications.
II. Investment, the labour market and the financial system: an overview
II.a The link between the labour market and investment
There are at least three interpretations concerning the effects of the presence of institutions on
the labour market – such as employment protection (severance pay and other costs of laying off
1 Legal institutions represent rigidities that hinder the efficient functioning of the
economic system – i.e. they hinder the traditional mechanism based on the demand for
Calcagnini—Saltari Maastricht - October 3, 2002 3
labour that drives firms to substitute away from labour towards more investment. This is
the Eurosclerosis view (Layard, Nickell and Jackman, 1991; Blanchard, 2000; Blanchard
and Wolfers, 2000). In this view, the evolution of European unemployment is mostly
due to the interaction of adverse shocks (such as the slowdown in TFP growth and the
increase in oil prices in the 1970s or the fluctuations in the real interest rate in the 1980s)
with the labour market institutions, which amplified the negative effects of the shocks
and intensified their persistence.
2 Institutions such as labour unions may be able to capture some of the financiers’ return
in the form of higher wages. This happens because investment, once committed, is a
sunk cost that cannot be easily reversed. The phenomenon is particularly strong when
investment has technological specificity, thereby strengthening the contractual position
of workers and weakening that of entrepreneurs. As a consequence, profits are reduced
along with the incentive for investment acquisitions (the so called hold-up theory (Grout,
1984; Caballero and Hammour, 1998, 1999)).
3 Institutions allow economies to overcome market failures such as those arising from
coordination failures – the corporatist view.
II.b The link between the financial system and investment
The financial system-investment link derives from the fact that financing decisions are relevant
for investment (be it continuation investment, investment in new firms, in R&D or in new
technologies). In turn, this implies that external and internal funds are not perfect substitutes - that
is, the MM theorem does not hold.
• Deviations from the MM world can be justified by capital market imperfections arising from
informational asymmetry between the entrepreneur and the financier, or due to adverse selection
or moral hazard (agency problem), search frictions or differences in legal institutions. Even
Calcagnini—Saltari Maastricht - October 3, 2002 4
disregarding the extremes of credit or equity rationing, these imperfections imply a higher user
cost for capital that negatively influences investment (Fazzari, Hubbard and Petersen, 1988; for a
review, Hubbard, 1998).
• Financial systems can be thought of as a means to acquire and disseminate information;
consequently, they alleviate the problems arising from informational asymmetries by monitoring
and selecting investment projects (Allen and Gale, 2001). The higher the development of the
financial system (in terms of the services they provide), the lower the cost of external financing,
and the faster the pace of capital accumulation (for empirical evidence, see Levine and Zervos,
1998; Rajan and Zingales, 1998).
• Banks and financial markets have, however, different merits in evaluating and selecting
investment projects. Therefore, bank-based systems and market-based systems tend to facilitate
different types of investment. For instance, it is usually thought that market-based systems can do
better in dealing with uncertainty. It is argued that in financial markets the large number of
participants with an independent opinion about a future event guarantees that their aggregate view
will correspond to the true probability of the event. This means that market-based financial
systems can better evaluate investment in new technologies (such as ICT). On the other hand,
bank-based systems may more efficient in evaluating long-term projects, such as those concerning
fixed capital (equipment, machinery). The long-term relationship means that banks can acquire a
considerable amount of information about the project; this can attract other small investors who
can delegate to the bank the task of screening and monitoring the investment. Therefore,
investors can avoid the costs associated with these actions (the relationship between the
characteristics of financial institutions – such as their ability to release information – and type of
investment is addressed in Carlin and Mayer, 2001, and Allen and Gale, 2001).
The role played by different labour markets and financial systems is at the centre of some
recent explanations of the poor performance of investment and unemployment in Europe. Indeed,
Calcagnini—Saltari Maastricht - October 3, 2002 5
there is by now a growing body of evidence that labour market institutional rigidities cannot be the
only responsible factor. Capital market imperfections could also be to blame; it is possible that these
imperfections have hindered investment, especially that in new technologies and new firms. In the
economic literature there are at least three models sustaining this interpretation:
1. In a world where agents are imperfectly aware of their opportunities, rationing exists both in
the labour and in the credit market. Rationing arises from the stochastic nature of a pair
matching process: between entrepreneurs, who want to invest in new firms but are credit
constrained, and financiers; and between entrepreneurs and workers (Wasmer and Weil,
2002);
2. Economies with more flexible financial markets will respond better and adapt faster to
technological changes by providing funds for investment and for new firm creation; in
contrast, economies with more rigid financial markets are constrained to principally relying
on cash flow to initiate investment in new businesses (Acemoglu, 2000);
3. Financial markets can be imperfect in the sense that they provide only low legal protection
for capital against ex-post appropriation by the other factors of production; by foreseeing
this phenomenon, ex-ante financiers will refuse to fund new investments (Belke and Fehn,
2000). Legal systems play a prominent role in this version of the hold-up theory. La Porta et
al. (1998) distinguish two legal traditions: the common law system (the English tradition)
and the civil law system (the German tradition) and state that the former gives investors a
stronger protection against ex-post appropriation.
In the next Section we will try to empirically explore the interaction of financial and labour
markets and their contribution to explaining investment decisions in Europe and the US.
Calcagnini—Saltari Maastricht - October 3, 2002 6
III. An empirical analysis of how labour and financial markets determine investment.
In order to analyse the relationship between the three markets (labour, capital and financial) we
opted for the following strategy.
First, we made use of information contained in the BACH database (European Commission,
2000). This database provides comparable data on the annual accounts of European and Non-
European (Japanese and U.S.) non-financial companies, broken down by major activity sector and
by size, for the period up to 1999. These data can be used as a basis for a whole series of
comparative analyses of the financial structures or profitability of companies by country, sector,
size or year. In our study we selected information available on the Manufacturing Industry (BACH
code 2) for the period 1987 – 1999, which was the most complete for the following twelve countries
(A, B, DK, F, FL, G, I, J, NL, S, SW, U.S.). Based on this information, as explained in the
Appendix, a set of variables was constructed. One of the advantages of using BACH, instead of
information from the respective National accounts, is the possibility of constructing variables
measuring investment returns and company financial conditions more directly related to investment
decisions.
Secondly, in all our models the dependent variable is investment. This approach does not
mean that we do not recognize an influential role for capital accumulation in determining labour
market outcomes. Indeed, there is a vast production of papers on the subject. However, a sound
conclusion is clearly far from being reached. Much of the debate between neoclassical and
Keynesian scholars concerns the existence of a relationship between medium- to long-term changes
in unemployment and medium- to long-term changes in private investment.1 In this paper we are
more interested in explaining changes (or differences) in investment demand with respect to
changes (or differences) in the labour and financial markets.
Therefore, as a third step in our strategy, we needed indexes reflecting differences in labour
and financial markets across countries and across time. In the latter case, as discussed in the
1 On this debate see Herbertsson-Zoega (2002), Ball-Mankiw (2002), Blanchard (2000).
Calcagnini—Saltari Maastricht - October 3, 2002 7
previous Section at the theoretical level, most applied research on investment stresses the role of
funds generated within firms as way of measuring the degree of financial market imperfection.
Namely, starting from the work of Fazzari et al. (1988), we would expect investment decisions to be
more cash flow sensitive when financial markets are characterised by imperfections than otherwise.
Notwithstanding, this approach has recently been challenged by Kaplan and Zingales (2000), as it is
still a common practice to augment investment models with variables measuring firms’ liquidity
conditions.2 The most widely used variable is cash flow.
However, we think that cash flow might not efficiently measure to what extent investment
depends upon financial market imperfections or, another way of looking at the same problem, upon
internally generated funds. The use of cash flow might be criticised for two aspects, at least. The
first one is that cash flow (profit/loss plus depreciation) depends on balance sheet policies and
therefore is more an accounting variable than an economic one. Secondly, investment decisions
may not only depend upon cash flow realized in one year, but upon the availability of other
financial resources, as represented by such factors as its liquidity position.
On one hand the latter, as measured by its net liquid assets is less volatile than cash flow.
However, on the other hand, it is closely related to cash flow, given that it might be thought of as
cumulated cash flow over time. Why should a firm’s investment project be delayed by insufficient
cash flow in the previous year if it might be funded by partially liquidating its assets or by using it
as collateral in the loan market? Moreover, financiers might see firms with a sounder liquidity
position as less risky and charge them a lower interest rate. For these reasons we will experiment by
adding a liquidity index (the current ratio) into the investment function, instead of the more
traditional cash flow variable.3
As for indexes concerning labour markets, a large number of papers has recently been
devoted to how different measures of corporativism and collective bargaining can influence
2 Recently, Gomes (2002) showed that cash flow may have significant effects even in the absence of financial frictions. 3 Sterken et al. (2002) use the ratio of liquid assets to capital stock as an indication of the availability of short-term funds. See also Small (2000).
Calcagnini—Saltari Maastricht - October 3, 2002 8
macroeconomic outcomes.4 The approach adopted in those papers gives rise to two different types
of problems. Firstly, it is not clear which variable is the “right” one to take into consideration: union
centralisation, union concentration, union density, degree of bargaining centralisation, etc.5
Secondly, all these labour market indicators are mostly qualitative (often subjective) and posses low
variability over time, rendering them unsuitable for use in panel models (i.e. with one dimension
across observations and the other one across time). Therefore, in this paper we take another
approach. Corporativism and collective bargaining influence firms’ profitability and financial
performance through pay levels and labour productivity. The latter might then be a function of
different bargaining system characteristics. More efficacious bargaining systems will likely result in
lower levels of conflict between firms and workers. Therefore, strikes are an indirect measure of the
functioning of labour markets. A higher number of strikes (and those of larger size in terms of the
numbers of workers involved) is likely to generate firms’ expectations of higher wages (or lower
profits) and produce higher uncertainty regarding production conditions. Both events are likely to
negatively impact investment.
Herein we also run a simple test of the assumed relationship between strikes and measures
of corporativism and collective bargaining.6 Our results show, for instance, a negative and
statistically significant relationship between the Kenworthy index of wage-setting coordination and
the average size of strikes (CONFL1). Furthermore, and even more conclusive is the negative and
statistically significant relationship with the overall importance of strikes as measured by
CONFL2.7 Finally, from an econometric point of view, strike variables overcome problems
associated with qualitative data and also provide enough time variability to be used in panel models.
Data on strikes were collected from the International Labour Office web site.
4 For instance, see Flanagan (1999) and Metcalf (2002). 5 A complete and extensive discussion on this matter can be found in Calmfors-Driffill (1988), Kenworthy (2000), Kittel (2001) and Leertouwer-de Haan (2002). 6 Results are not reported here, but they are available from the authors upon request. 7 See Appendix for the way CONFL1 and CONFL2 are calculated. We also obtained a negative relationship between strikes and Iversen’s index (see Iversen, 1999 and OECD, 1997).
Calcagnini—Saltari Maastricht - October 3, 2002 9
Our model specification includes traditional determinants of investment, such as
profitability, relative prices, financial or liquidity variables, together with additional variables
reflecting labour market conditions. The latter include conflict variables (i.e. strikes) or income
distribution variables like the ratio of labour income over value added. Table 1 shows average
values for the variables used in our analysis.
Panel results (fixed or random effects) are shown in Table 2; random effect estimates are
singled out by the presence of Hausman’s test p-values larger than 5%, and by the simultaneous
presence of the estimated intercept.
All variables are defined and constructed as explained in the Appendix.
The real return on investment (ROIR) and current asset ratio (GLIQ) do not require lengthy
explanation, since they are meant to measure investment profitability and firms’ liquidity
conditions, respectively8, and expected to have both positive estimated coefficients. A more detailed
discussion is needed in the case of labour market variables, instead.
WRKSTK is the relative number of people who participated in strikes with respect to total
employment; CONFL1 is the average number of people on strike per strike, while CONFL2 is the
number of strikes “weighted” by the strike participation rate (i.e. WRKSTK). The main difference
between CONFL1 and CONFL2 is that the former is likely influenced by the average size of firms
involved in strikes that, in turn, depends upon the firm size distribution of each national economy.
Diversely, CONFL2 reflects the frequency of strikes and their importance in terms of the relative
number of workers involved. The expected sign of the estimated coefficients of this class of
variables is ambiguous, given that the impact of labour market conflicts can both enhance and
detract from the productivity performance of firms.9 Besides the effect on investment through
productivity, labour conflicts might represent a measure of uncertainty prevailing in the economy.
Recently, a vast amount of economic literature has been dedicated to determining the exact role
8 According to Gilchrist-Himmelberg (1998), ROIR represents a proxy for the marginal productivity of capital stock. 9 On this topic see Metcalf (2002).
Calcagnini—Saltari Maastricht - October 3, 2002 10
played by uncertainty on investment. Our contribution on the matter stresses a negative relationship
between investment and uncertainty.10
As an alternative to variables WRKSTK, CONFL1 and CONFL2, we used an income
distribution variable, namely the ratio of labour income to value added (CLVAD). Again, the
estimated coefficient of CLVAD is, ex-ante, ambiguously signed; indeed, we might expect a
negative coefficient if a larger share of labour income meant lower profits, or a positive sign in the
case in which it became profitable for firms to substitute labour with capital.
Our richer model specification includes two more variables.
The first variable (CFCONFL2) is the product between CONFL2 and the ratio of cash flow
to turnover.11 CFCONFL2 is designed to describe how labour conflicts cause investment, once
firms’ ability to generate liquidity across countries is taken into account. One might expect that
firms with enough cash flow react to more intense strike activity by accelerating the substitution
process of labour with capital. On the other hand, as discussed above, one might expect that a
higher level of CONFL2 is associated with higher uncertainty; therefore, firms might find it optimal
to employ cash flow for uses other than investment, in order to reduce their leverage and not to
expand the production capacity.
The second variable (CFLEV) is the product between leverage (LEV) and the ratio of cash
flow to turnover. Its purpose is to check the interpretation according to which firms might use cash
flow to repay their debt instead of funding new projects. In other words, different levels of cash
flow among firms in different countries might not merely reflect different degrees of financial
market imperfections, but different levels of leverage and/or interest rates. For instance, two firms
10 See Calcagnini-Saltari (2001, 2000), Lensink et al. (2001). 11 We also experimented variable CFCONFL1 (i.e. the product between CONFL1 and the ratio of cash flow to turnover), but with no statistically significant results.
Calcagnini—Saltari Maastricht - October 3, 2002 11
within the same country, and with the same investment opportunities and access to capital markets,
might show different cash flow-turnover ratios due to their different initial levels of leverage.12
Finally, we included a relative price variable calculated as the ratio of the investment price
deflator to the value added price deflator (PRELI). PRELI is meant to control for the classical
demand effect on price changes. Indeed, this effect seems to have played an important role in
explaining the different pace shown by the investment process in Europe and the US (European
Commission, 2001, p.103).
Regression results are shown in Table 2. All models, but (1), exclude the dependent variable
(I) lagged one year among the regressors, the reason being the statistically non significant
coefficient of the autoregressive term.13 Not handling dynamic regressions allows us to make use
of most traditional panel estimation methods (i.e. not use GMM methods) to obtain unbiased
estimated coefficients. In order to check for the potential role of firms’ financing patterns in
different countries—given the traditional classification between capital market-based financial
systems (the U.S.) and bank-based ones (continental Europe)— models 6 and 7 do not include the
U.S.
Estimated coefficients for the first two variables (ROIR and GLIQ) are consistent with
traditional priors: investment is positively influenced both by capital profitability and firms’
financial conditions. In order to evaluate the relative importance of the two variables, Table 3 shows
their respective beta coefficients.14 To simplify the analysis, particularly given the small differences
observed, the beta coefficients have been calculated only for models 2 through 5.
With the exception of model 2, investment is more sensitive to liquidity conditions than
profitability. Indeed, a 1 standard deviation increase in GLIQ determines a correspondent increase
12 We also tested the cash flow variable by itself, but its estimated coefficient is always negative and statistically not significant. Recently, it has been argued that the coefficient of the cash flow variable is ambiguously signed, contrary to the traditional view of a positive coefficient. On this topic see Kaplan-Zingales (2000). 13 The result is unexpected and it might depend upon the method we followed to construct the investment series from companies’ balance sheet as explained in the Appendix. 14 The beta coefficients are the regression coefficients you would have obtained had you first standardized all of your variables to a mean of 0 and a standard deviation of 1. Thus, the advantage of beta coefficients is that the magnitude of these Beta coefficients allows you to compare the relative contribution of each independent variable in the prediction of the dependent variable.
Calcagnini—Saltari Maastricht - October 3, 2002 12
in I by 0.16, which is only 0.11 in the case of ROIR. Theoretically, the result may not be
convincing, but from an empirical point of view an explanation has always been found in the
context of the “Tobin’s q” models. Indeed, investment profitability is correctly measured by its
marginal return, but the latter is empirically difficult (if not impossible) to observe. It has been
shown that the use of the average profitability variable (like our ROIR variable) instead of marginal
profitability results in downward-biased coefficients. This seems to be the case in our estimates as
well.
Comparing the estimated coefficients of models 4 and 5 with those of models 6 and 7, which
exclude data for the U.S., we observe only marginal and statistically significant differences.
Therefore, a first conclusion is that the role of profitability and liquidity in determining investment
is quantitatively similar in Europe and in the US.
As for the conflict variables, the estimated coefficient of WRKSTK in model 1 suggests that
a higher participation rate of workers to strikes positively influences investment. The result is
consistent with the interpretation according to which firms invest to substitute labour with capital.
However, given that the estimated coefficient is only marginally significant, we used two
alternative variables to WRKSTK.
Model 2 includes both the average number of workers per strike (CONFL1) and the number
of strikes weighted by the strike participation rate (CONFL2).15 Apparently, the estimated
coefficients for these two variables seem to offer alternative interpretations. Indeed, the positive
coefficient of CONFL2 suggests a positive influence of conflicts on investment, while the negative
coefficient of CONFL1 supports the opposite interpretation.16
Higher values of CONFL1 mean that a larger proportion of workers on strike belongs to
large-sized firms. In turn, this might mean that larger firms reacted to conflicts by delaying or
reducing their investment. A typical behaviour pattern of Italian firms, for instance, was to reduce
15 Models that include CONFL1 and CONFL2 exclude observations for Germany for which we do not have information on the number of strikes. See Table 1. 16 The sign of the CONFL2 coefficient is likely influenced by the use of WRKSTK in the variable construction. However, the coefficient of CONFL2 is more precisely measured than the coefficient of WRKSTK. See Table 2.
Calcagnini—Saltari Maastricht - October 3, 2002 13
in-home production in favour of outsourcing production in smaller firms17. This might explain the
negative sign of the CONFL1 coefficient, given that our database is biased towards medium- and
large-sized firms.
Instead, CONFL2 provides information both on strike frequency and on the proportion of
workers involved. Therefore, it measures what we may call “strike intensity”. Higher values of
CONFL2 likely mean that all types of firms (small- and large-sized) are characterized by conflicts;
in this case the optimal strategy would be to invest more to substitute labour with capital (i.e.
moving/deploying production from large-sized towards small-sized firms would no longer be a
feasible solution). This interpretation on the role of CONFL2 finds empirical support from a panel
regression with the capital-per-employee ratio as dependent variable and the same independent
variables of Model 2 (ROIR, GLIQ, CONFL1, CONFL2 and PRELI). Indeed, the coefficient of
CONFL2 is positive and statistically significant at the 5% probability level, meaning that higher
conflict levels make it convenient for firms to move towards more labour saving technologies.18
Beta coefficients show that CONFL2 plays an important role in investment decisions, even
larger than that of profitability (ROIR); as for CONFL1, its beta coefficient is slightly over 50% of
that of CONFL2 in models 2 and 5, but much smaller in the case of model 4.
The relative weight of CONFL1 and CONFL2 does not change much, even when
observations for the US are excluded from the sample. Only when CFCONFL2 is included among
the regressors, we observe a sharp increase in the beta coefficient of CONFL2. However, this
change is partially compensated for by the negative coefficient of CFCONFL2. Specifically, the
latter supports the interpretation according to which firms are oriented towards reducing investment
during periods characterized by high levels of conflict and high cash flows. As discussed above, in
17 More recent behaviour is that of producing more labour intensive goods abroad. 18 The BACH database does not provide employment information for several countries considered in our analysis. Therefore, we were not able to construct a capital-per-employee (KN) variable to use in our regressions. Therefore, we were constrained to relying on sources not completely consistent with our database. Specifically, we used data provided by Easterly and Levine (1999). For this reason we opted to not report panel estimates for the model with KN as a dependent variable. However, results are available from the authors upon request.
Calcagnini—Saltari Maastricht - October 3, 2002 14
these situations and with imperfect capital markets firms might find it more convenient to use cash
flow to create more balanced financial conditions (i.e. reduce their leverage).
From the point of view of the labour-financial market relationship, the negative coefficient
of CFCONFL2 has another interesting interpretation. Variable CFCONFL2 (i.e. cash flow times
CONFL2) helps to distinguish firms with high cash flows from those with low cash flows in
economies, for instance, with high levels of labour market conflict. Estimated coefficients suggest
that the two groups of firms behave differently. On the one hand, firms with high cash flow will
reduce investment in the presence of high conflict levels, thus reinforcing the negative effect of
CONFL1 on I; on the other hand, firms with low cash flows will pursue a strategy of increasing
their capital-labour ratio in the attempt to generate more cash flow. Indeed, we have already noted
that investment is positively caused by more balanced liquidity conditions; therefore, it is likely that
firms in economies with higher levels of conflict are also those with higher leverages and lower
current ratios.19
The negative sign of the estimated coefficient of CFLEV confirms this interpretation: firms
with higher levels of leverage and cash flows show lower investment demand. Indeed, this
behaviour concerning the use of cash flow is rational if we keep in mind that all the countries in our
database have well-developed financial markets. In those markets companies that show a sound
balance sheet are always able to funds their projects (either by issuing securities and/or accessing
the bank-loan market). Again, we note that differences between estimated coefficients of models 5
and 7 (with or without the U.S.) are quite small; this result confirms that capital market-based and
bank-based financial systems seem to play no significant differential role in funding investment.
As for the relative importance of CFCONFL2 and CFLEV in the prediction of the dependent
variable, the size of their beta coefficients is approximately similar: larger in the case of
CFCONFL2, but also statistically significant at the 10% level.
19 Indeed, the correlation coefficient between average values of GLIQ and CONFL2 (see Table 1) is –0.39, while the correlation coefficient between average values of LEV and CONFL2 is 0.30.
Calcagnini—Saltari Maastricht - October 3, 2002 15
Model 3 is an alternative specification to models 1 and 2 where conflict variables have been
substituted by an income distribution variable, namely the ratio of labour income to value added
(CLVAD). 20 We were forced to exclude variables CONFL1 and CONFL2 from model 3, given
their collinearity with CLVAD. In other words, conflict and income distributional variables seem to
measure the same relationship between investment, on one hand, and labour market conditions, on
the other. Specifically, the estimated coefficient of CLVAD is positive and statistically significant,
meaning that economies characterized by an income distribution favourable to labour are also those
with more incentives to substitute labour with capital. 21
The relative importance of CLVAD is reflected in its beta coefficient, the size of which is
quantitatively comparable to that of GLIQ and, on average, larger than that of CONFL1 and
CONFL2 (see Table 3).
Finally, all models except model 1 include the relative price of investment (PRELI). The
estimated coefficient of PRELI is statistically significant (with the only exception being model 6)
and shows the expected negative sign: an increase in the investment price relative to that of product
reduces investment. The relative contribution of PRELI in the prediction of the dependent
variable—as measured by its beta coefficient—is smaller than that of the other variables and
comparable to that of CONFL1. Moreover, there are no significant differences between the
estimated coefficient with or without the U.S.22
IV. Conclusion and policy issues. This paper has aimed at analysing how labour and financial markets influence investment.
Specifically, we stressed the importance of considering labour market conditions within the most
20 Model 3 excludes the U.S. given that value added cannot be calculated from balance sheet data for the American companies. 21 This interpretation, based on results that also include observations for Germany, allows us to confidently extend the results of models including variables CONFL1 and CONFL2 to that country as well. 22 Table 3 does not show beta coefficients referring to the sample that exclude the U.S., but they are available from the authors upon request.
Calcagnini—Saltari Maastricht - October 3, 2002 16
traditional theoretical framework that assigns a significant role to financial market imperfections in
determining capital accumulation. This approach has two main advantages. First, investment
models suffer less from misspecification errors; secondly, it offers a more complete set of policy
issues than traditional analyses.
Our results show that:
1. Financial markets’ configuration (market- vs. bank-based) does not significantly matter. Our
estimates excluding data for the U.S. economy are not significantly different from those
obtained for the whole sample. Our results are consistent with those of Mariani and Padoan
(2002).
2. Most importantly, investment depends upon the degree of financial market imperfections. A
higher degree of imperfections means that a firm’s value (or its profitability) depends on its
financial policy (its liquidity conditions, leverage, etc). Therefore, away from the MM
world, finance matters.
3. Labour market conflict, as a result of institutional bargaining set-ups, has two effects on
investment. On one hand, it reduces investment by causing a decrease in expected
profitability; on the other hand, it makes it convenient for firms to substitute labour with
capital. Both the size effect on firms’ capacity and that in favour of more labour saving
technologies negatively feed back on the labour market by reducing employment
opportunities.
4. Economies characterized by more labour conflicts are also those with less favourable
financial indicators (i.e. lower liquidity and higher leverage); therefore, in these economies
labour conflicts have the greatest negative effect on investment and job opportunities.
Investment is traditionally considered one of the most important economic variables. As a
component of aggregate demand it helps determine both its level and volatility. On the supply
side, it is the means through which innovations are introduced into the economy, it determines
Calcagnini—Saltari Maastricht - October 3, 2002 17
the expansion path of productive capacity and, therefore, provides opportunities to increase
employment. Economic policies to promote investment should therefore promote policy moves
towards more efficient capital markets and, at the same time, bargaining systems that help
reduce labour market conflicts. As for the latter, economic literature is still debating whether a
centralised bargaining system is preferable to a decentralised one. Our view is that, during the
last decade, more changes occurred in the European financial markets than in national labour
markets. While the consensus on the efficacy of the former is widespread, too many differences
still characterise the latter. It is therefore imperative that more work be dedicated to improving
understanding of different bargaining systems, both on a theoretical level as well as the practical
one in which policy tools are chosen.
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Table 1
Variables’ average values: 1988-1999
Country I ROIR GLIQ PRELI CLVAD CFTUR LEV WKSTRK NRSTRK CONFL1 CONFL2 Kenworthy 1999 (a)
Numbers in parentheses at the top of columns correspond to models of Table 2
Calcagnini—Saltari Maastricht - October 3, 2002 22
Appendix
Variable definition
I (Investment) = Acquisitions of tangible fixed assets (R261), when available, or first difference of Tangible fixed assets (C2). The latter has been expressed as a ratio to Turnover (TURN) in order to be consistent with the former; source: BACH.
ROIR (Real return on investment) = Net operating profit/Tangible fixed assets (V*TURN/C2*TASS) – inflation (growth rate of Industry value added deflator); source: BACH and OECD, National Accounts. GLIQ (Current ratio) = Total current assets (D) /Total current liabilities (F); source: BACH CF (Cash flow) = Profit or loss for the financial year (R21) + Depreciation on intangible and tangible fixed assets (R7A) as a ratio of Turnover; source: BACH. CLVAD = Labour cost over Value added (R6*TURN/VADD); source: BACH. LEV (Leverage) = (Amounts owed to credit institutions (short- and long-period) + Other financial creditors (short- and long-period) + Debenture loans)/ Capital and reserves (F2+F101+I1+I2+I101)/L; source: BACH. PRELI = Investment price index deflator / Value added price index deflator; source: OECD, National account. WRKSTK = Number of individual on strike as a percentage of total employment; source: ILO. CONFL1 = Number of individual on strike per strike; source: ILO. CONFL2 = WRKSTK times Number of strikes; source ILO. CFCONFL2 = CF times CONFL2. CFLEV = CF times LEV.
