MACRO: Flexible Capital User Costs and Investment Dynamics with Non-Convex Adjustment Costs; Dr Eugene TAN (University of Toronto)

Abstract

Using firm-level micro-data from India, we show that the user cost of capital, in the form of depreciation and maintenance rates, is highly variable within and across firms. Moreover, we show that such variation is endogenous to the firm and partly reflects firms’ flexibility to bypass investment irreversibility constraints. By embedding endogenous user costs into a standard neoclassical investment model with capital adjustment costs, we show that variability in user costs amplifies the dispersion of marginal product of capital by around 79% relative to an otherwise equivalent model with fixed user costs. Moreover, in the context of the real business cycle literature, endogenous maintenance converts capital into a quasi-variable input, thus dampening the effects of uncertainty shocks.