How Important is Uncertainty in Accounting for Differences in Investment and Output Across Countries?

Abstract

I offer differences in uncertainty of the industry-level investment environment as an explanation for the observed differences in the investment good price and output level across countries. I present a model economy where the tax rate on industry investment follows a stochastic process. In this environment, a higher level of uncertainty makes investment more inefficient (i.e. increase the expected cost of producing unit of capital), and this is reflected in higher investment good prices. An investigation of industry-level investment data across countries shows that the patterns of investment dynamics (i.e features or statistics of investment sequence) in relation to output level are consistent with the implication of the model. I assign model parameter values to countries of different output levels so that the simulated investment sequences from the model mimick the actual investment sequences. I find that uncertainty can accout for all of the observed differences in the investment good price, and a significant portion of the differences in the output level across countries. Differences in uncertainty between the US and Ethiopia can account for difference in the investment good price by factor of up to 4, and difference in the output level by factor of up to 16 between the two countries.