Relative prices and investment rates

Abstract

We construct a panel for the price of aggregate investment over consumption and report the following observations. (1) Relative price differences across countries are large over the entire sample period, and this conclusion is not affected by excluding non-tradable consumption goods. (2) Relative price dispersion has decreased during the sample period. (3) Relative price changes are not persistent across periods, while average price levels are. Moreover, the persistence in relative price levels is higher for countries at low relative prices. We show that the relative price of investment is negatively correlated with investment rates in a cross section of countries. The standard one-sector growth model is a natural framework to study quantitatively the effects of barriers to capital accumulation since there is a very simple mapping between barriers to investment and relative prices in this environment. We simulate a calibrated version of the model, in which barriers follow a stochastic process common to all countries and estimated using relative price data, and obtain statistics for investment rates that closely resemble what we observe in the data. In particular, the model accounts for 90% of the 1985 Gini index of relative investment rates and the decline in investment rate dispersion over time. The model has two limitations as a theory of development. First, it cannot account for the income disparity in the data unless we assume unmeasured capital with barriers affecting the broad measure of capital. Second, even under these extreme assumptions, the model cannot account for the evolution of income disparity over time.