Investment for Survival
Deregulation of any government rules restricting the entry of new firms, usually intensifies competitive pressure on incumbent firms. How does it influence their investment behavior? This is the question addressed in the present paper. Investment is broadly defined here as the attempt of firms to increase their future profits at the expense of their current net cash flow. Given the quality and variety of the firms’ products, it includes investment meant to decrease their future operation costs as well as investment for increasing their future production capacity. The former may be referred to as cost-reducing investment and the latter as capacity-increasing investment.1 For instance, let us consider a small open economy protecting a domestic industry against foreign competition by means of tariffs and suppose that the government credibly announces its plan to reduce the rate of tariffs in the near future (for instance, on the basis of internationally agreed trade negotiation). On the one hand, it seems likely to discourage the capacity-increasing investment of domestic firms since the trade liberalization will diminish their future sales. On the other hand, it may promote their cost-reducing investment to prepare for severer competition with foreign rivals in the future. In the words of business people, the anticipation of future competition may give rise to investment for survival.
KeywordsMarginal Cost Cash Flow Capital Stock Trade Liberalization Domestic Firm
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