The User Cost of Capital: Link from Macroeconomic Policy to Business Decisions

Abstract

In measuring the user cost or rental price of capital assets and associated rates of return for analysis of production and growth, economists have neglected to incorporate the return to financial capital that economic logic prescribes, and for the most part have ignored the distinction between equity and debt financing as well. A consequence of omitting these factors is persistent measured differences in rental prices of capital across industries, based on differences in measured rates of return. 1 Increasing concern with the decisions of enterprises engendered by deregulation, privatization and capital markets research make it important to extend the economic theory of the cost of capital to embrace these concepts, and thus to reconcile the practices in production and growth economics with those of finance and accounting. Because the user cost of capital is so strongly influenced by the macroeconomic environment, it is important for policy analysis to accurately quantify those influences. With this aim, the current chapter briefly revisits the rate of return and rental price concepts conventionally used in modeling the investment decisions of the firm, and in studies of productivity and economic growth, and shows how incorporating these concepts into practice alters rates of return and the rental prices of physical assets. To our knowledge, the production literature in economics has been silent concerning the role of financial capital until its treatment by Norsworthy and Jang (1992) and Tsai and Norsworthy (1991). The sole exception is Nguyen and Andrews (1986), however, the published version includes only financial working capital. 2