France: Selected Issues
Author: International Monetary Fund. European Dept.
Publication Date:
03 Jul 2014
eISBN:
9781498304023
ISBN:
9781498304023
Language:
English
Keywords:
ISCR; CR; France; export; investment; value; investment activity; investment goods; co-integrating equation link investment; investment theory; Stocks
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This Selected Issues paper reviews business investment patterns in France during the crisis. The main motivation is to explore whether investment has recently evolved in line with established determinants or displayed somewhat unconventional dynamics. This paper addresses three distinct questions. First, has recent investment behavior essentially been consistent with past trends or is there any discernible structural break as a result of the crisis. Second, what drove the contraction in investment during the crisis. Third, what is the investment outlook and can a swift and strong rebound going forward be expected. The paper presents main results and the outlook for investment.

Abstract

This Selected Issues paper reviews business investment patterns in France during the crisis. The main motivation is to explore whether investment has recently evolved in line with established determinants or displayed somewhat unconventional dynamics. This paper addresses three distinct questions. First, has recent investment behavior essentially been consistent with past trends or is there any discernible structural break as a result of the crisis. Second, what drove the contraction in investment during the crisis. Third, what is the investment outlook and can a swift and strong rebound going forward be expected. The paper presents main results and the outlook for investment.

The Drivers of Business Investment in France: Reasons for Recent Weakness1, 2

A. Introduction

1. While the resilience in private consumption has supported domestic spending in France during the crisis, business investment remains a substantial drag on growth. In 2013, private consumption was 2.5 percent higher than its pre-crisis level whereas business investment was still 9 percent lower than its pre-crisis peak.

2. This paper reviews business investment patterns in France during the crisis. The main motivation is to explore whether investment has recently evolved in line with established determinants or displayed somewhat unconventional dynamics. We address three distinct questions. First, has recent investment behavior essentially been consistent with past trends or is there any discernible structural break as a result of the crisis? Second, what drove the contraction in investment during the crisis? Third, what is the investment outlook and can we expect a swift and strong rebound going forward?

3. The rest of the paper is organized as follows. Section II describes investment developments during the crisis. Section III discusses the estimation methodology and presents the data used in the analysis. Section IV puts forward the main results and discusses the outlook for investment and priors underpinning our projections.

B. Stylized Facts

4. The collapse of investment in the immediate post-Lehman period is yet to be fully reversed (Figure 1). Following the sharp fall over 2008Q2–2009Q3, business investment rebounded before stabilizing during the first half of 2011. The arrival of the Euro area sovereign debt crisis was followed by two years of contraction in investment, which eventually rebounded in 2013Q4 after relative growth resilience in 2013. Overall, business investment at end–2013 was 9.3 percent below its pre-crisis peak. This is in contrast with developments in other demand components, which have supported GDP during the crisis and exceed by now their pre-crisis marks. Specifically, private and government consumption and exports currently are 2.5, 8.2, and 4.4 percent higher than their 2008 marks, respectively.

Figure 1.
Figure 1.

France: Business Investment during the Crisis

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Source: Haver Analytics, and staff calculations.

5. There are a number of variables that can potentially explain the sluggish investment during the crisis. They include depressed growth, financial and financing conditions (declining profit margins, higher indebtedness, and costly capital), as well as deteriorating confidence and heightened uncertainty.

  • Profit margins. French NFCs profitability, as measured by gross operating surplus as a share of gross value added has deteriorated since the outset of the crisis (Figure 2). While a comparison of levels across countries is difficult because of methodological differences, the relatively worse situation of French companies is also apparent in the gap between current profits and historical averages. Indeed, the profit share of German and Spanish NFCs is currently above its 1991–2007 average levels, unlike that of French companies, which has decreased significantly since 2008. Weak and recently deteriorating self-financing may have weighed on NFCs’ investment capacity.

  • Confidence and uncertainty. Confidence and uncertainty, as measured by firms’ average and divergence in expectations about future economic conditions, have also deteriorated during the crisis (Figure 3). After a major setback at the trough of the crisis, confidence bounced back to reach historical highs in early 2011, before declining again throughout 2011–12. Although confidence has improved thereafter, it remains below average levels. Business uncertainty has abated considerably in France after the sharp increase registered in 2008, yet it remains high by historical comparison.

  • NFCs financial conditions. French NFCs’ debt to equity and debt to financial assets ratios have generally stayed below the euro area average and those in Germany, Italy or Spanish peers (Figure 4). The relatively healthy financial situation of French NFCs would in turn support investment activity, as would favorable financing conditions (i.e. inexpensive cost of capital) during the crisis.

Figure 2.
Figure 2.

France: Profit Margins

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Source: : INSEE, Eurostat, and IMF Staff calculations.1/ Ratio of value added deflator to consumption deflator.
Figure 3.
Figure 3.

France: Confidence and Uncertainty Indicators

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Source: European Commission Business and Consumer Surveys and Authors’ calculations.1/ Average of responses to survey question “how do you expect your production to develop over the next three2/ Dispersion of responses to survey question “how do you expect your production to develop over the next three months?” See section III.B. for details on the construction of the index.
Figure 4.
Figure 4.

France: NFCs’ Financial Conditions

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Sources: Haver Analytics, ECB, and IMF Staff calculations.1 See Section III.B for calculation.

C. Priors and Data Requirements

Estimation Methodology and Priors

6. We interpret investment trends in France by means of a co-integration model. This type of model aims to establish a long-term relationship between investment and its fundamental determinants. Deviations from the estimated long-term relationship are in turn explained by a short term dynamic equation.

7. We use quarterly data covering the period 1995Q1-2013Q3 to estimate the co-integration model

  • Long-term relationship. The co-integration regression is estimated by fully modified OLS (Phillips and Moon, 1999; Pedroni, 2000, 2001; Kao and Chiang, 2000; Mark and Sul, 2003), which produces asymptotically unbiased, normally distributed coefficient estimates. The co-integration relationship takes the form:

    It=c+βXt+εt(1)

    where I is investment, c is the constant of the regression, and X is a vector of variables comprising the value added of the private sector, capacity utilization, and a set of financial and financing conditions (profit margins, corporate debt, the real cost of capital3, and the share of equity in total liabilities). All variables enter the regression in log levels.

  • Short-term relationship. The dynamic equation is estimated by OLS. It links changes in investment to changes in its long-term determinants; swings in firms’ confidence and uncertainty about future economic conditions4; as well as deviations of investment from its long-term value (or error correction term). The dynamic relationship therefore takes the form:

    ΔIt=βΔXt+γΔUt+δECMt−1+εt(2)

    where Δ denotes first differences, U includes confidence and uncertainty indicators, and ECM represents the deviation of investment from its long-term value.

8. The priors we test are informed by conventional investment theory and are summarized as follows:

  • Output. A standard accelerator view of investment suggests that investment outlays depend on expected output growth.

  • Spare capacity. A margin of spare capacity weighs on the level of investment and vice-versa, tight capital utilization signals constraints in the use of capital and acts as a spur to investment. A distinct response of investment to capacity utilization (over and beyond value added) may also be explained by productivity shocks affecting the ratio of capacity utilization to value added.

  • Financial and financing conditions. A range of such factors can influence investment spending: (i) low corporate profits can adversely affect investment plans insofar as external finance is more difficult to access (or is more expensive) than internal funds; (ii) highly indebted firms may defer investment as a means of adjusting the balance sheet to conserve cash and reduce debt; (iii) a high real cost of capital is likely to reduce investment in order to align the rate of return on investment to the cost of capital; (iv) and the lower share of equity in total liabilities, the lower investment.

  • Confidence and Uncertainty. Since it is difficult to reverse investment once new capital is installed, low confidence and elevated uncertainty increases the option value of deferring investment.

Data and Measurement Issues

9. All series are taken directly from conventional data sources, except the real cost of capital and the confidence and uncertainty indicators which are constructed for the purpose of the regressions. Business investment and the value added of the private sector come from National Accounts (NA), as does profit margins (which we calculate as the share of gross operating surplus and mixed income in gross value added), and the equity to total liabilities ratio (which is computed from the corresponding stocks allocated to NFCs by the NA financial balance sheet system). Capacity utilization is taken from the INSEE quarterly business survey.

10. The real cost of capital is computed as the weighted cost of different sources of financing (net of the depreciation rate) adjusted for the relative price of investment goods:

rk=(r−π+δ)*P1PVA(3)

where rk is the real cost of capital, r the weighted nominal cost of short- and long-term debt and equity, π is the GDP deflator inflation, and P1PVA is the investment goods deflator relative to GDP deflator. Equation (3) follows from neo-classical theory (Jorgenson, 1971) and postulates that, in equilibrium, companies invest up to the point where the return on capital equals the cost of financing it. The cost of equity is calculated as follows:

rs=100(Dt+1Et+Dt+1−DtDt)(4)

where rs is the cost of equity, D is total National Accounts dividend payments, and E is total National Accounts shares and other equity.

11. The indicators measuring firms’ confidence and uncertainty about future economic conditions are constructed from business surveys. Specifically, we rely on the responses to the forward-looking question in the European Commission Business and Consumer Surveys “how do you expect your production to develop over the next three months?” Confidence measures the average expectations about future economic conditions, thus we compute it as the average of survey responses. Uncertainty measures the divergence in firms’ views about the economic outlook, thus we compute it as the dispersion in survey responses. The basic idea is that a divergence of economic agents’ expectations about the future should be a sign of higher uncertainty in the economy. To measure this divergence, we use the Theil’s formula:

uncerta⁢i⁢nty=1n*Σi=1⁢  to⁢  nαi*log⁡(αi)(5)

where log denotes the neperian logarithm, αi is the share of respondents choosing each type of response, and n is the number of response categories for the forward-looking question, which is equal to 3 (increase, remain unchanged, decrease). The uncertainty index so computed ranges between 0 (respondents fully agree on economic prospects, whether gloomy or bright) and 0.3 (greatest divergence in perceptions about the future across respondents).

D. Business Investment: Past Behavior and Future Prospects

Business Investment Drivers

12. Our evidence supports a role for many of the aforementioned factors in shaping business investment spending in France. The estimates account for much of the variation in France investment over time (Figure 5).

Figure 5.
Figure 5.

Business Investment in France: Actual and Fitted Values

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Source: Staff estimates.

13. The elasticities estimated from the co-integrating equation link investment to its long-term determinants (Table 1). In the long term, a one percent increase in the value added of the private sector will lead to an increase in investment of almost 1.5 percent5; the estimates suggest a one percent increase in the profit margin raises investment by ½ a percent; in addition, a one percent rise in capacity utilization translates into a 0.3 percent increase in investment; also, a one percent increase in the real cost of capital will lead to a decrease in investment of 0.1 percent; and a one percent decrease in the ratio of equity to total liabilities will dampen investment by 0.1 percent. Although the level of NFCs’ indebtedness may have been important elsewhere, we have not found evidence that it operated in France.

Table 1.

Cointegration Relationship

(France, 1995Q1-2013Q3)

article image
Source: Staff estimates.Note: Fully modified least squares estimator; 72 observations.

14. The estimated parameters in the dynamic equation reveal several interesting results for the period considered (Table 2). Investment growth responds positively to contemporaneous gains in output, reductions in spare capacity, and increases in profit margins. Although rightly signed, uncertainty is not significant. When investment deviates from its long-term determinants, the error correction term brings the system back to the long-term equilibrium from the following quarter.

Table 2.

Dynamic Relationship

(France, 1995Q4-2013Q3)

article image
Source: Staff estimates.Note: OLS estimator; 72 observations.

15. What were the main factors underlying business investment dynamics during the crisis? (Figure 6). During 2008Q2–2009Q3 investment fell sharply in France (by almost -16 ppts cumulatively). A recovery followed over 2009Q4–2011Q4, with a partial catch up of the previous decline (around +12 ppts cumulatively), after which investment decreased again, if more moderately (about -5½ ppts cumulatively over 2012Q1–2013Q3).

Figure 6.
Figure 6.

France: Business Investment and Contributions

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Source: Staff estimates.

  • 2008Q2–2009Q3 period. The most important factor pushing down investment in 2009 was the contraction in value added (58 percent of the predicted fall in investment), followed by declines in capacity utilization and profit margins (34 percent and 31 percent of the predicted fall respectively); the lower cost of capital played an offsetting role and encouraged investment (25 percent of the variance), while the improvement in the share of equity in total liabilities only played marginally.

  • 2009Q4–2011Q4 period. Investment behavior during this period was dominated by the accelerator motive (82 percent of the variance). Investment growth also responded markedly to rising capacity utilization (43 percent of the variance). Higher real cost of capital, and firms’ lower profit margins and equity ratio dampened investment (19½, 3½, and 3 percent of the variance, respectively).

  • 2012Q1–2013Q2 period. In a low inflation environment, the rise in the real cost of capital accounted for much of the predicted drop in investment (44 percent of the variance). Weak capacity utilization weighed heavily on investment too (28 percent of the variance), as did continued declines in profit margins (22 percent of the variance). The accelerator played a smaller role (7 percent of the variance).

The Outlook

16. Based on our analysis of the drivers of business investment and our priors on such determinants, we expect investment to contribute to growth moderately in 2014 before firming up vigorously as of next year. Our projection for investment is based on: (i) an accelerator effect linked to the upturn in growth; (ii) the waning drag from spare capacity—capacity utilization is set to return to its average level of 2000–2007 by 2019; (iii) improved profitability (by 4 percentage points over the projection period) as moderate wage growth during the recovery correct past biases in the distribution of income towards labor; and (iv) the persistence of favorable financing conditions, i.e. the continuation of current levels for the cost of capital and the equity ratio.

A01ufig01

France: GDP and Investment Projections

(In index number, 2008Q1=100)

Citation: IMF Staff Country Reports 2014, 183; 10.5089/9781498304023.002.A001

Sources: Haver and Staff projections.

17. Recent and prospective tax changes that increase after-tax profitability should have an additional effect positive effect on investment. These effects are not explicitly captured in the model which is estimated on the basis of gross profit margins. The positive outlook for the recovery of investment also reflects the lack credit supply constraints, the absence of a NFCs debt overhang, and the abatement of uncertainty.

References

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  • Pedroni, P., 2000, “Fully Modified OLS for Heterogeneous Cointegrated Panels,” Advances in Econometrics, Vol. 15, 93–130.

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1

Prepared by Esther Pérez Ruiz (EUR). I am grateful to Derek Mason for excellent research assistance.

2

The data underlying this paper pre-date the ESA2010 revision in National Accounts of May 15.

3

See next section for details on measurement.

4

See next section for details on measurement.

5

In the very long run, the investment to GDP ratio shows little or no trend. Consistent with this, the elasticity of investment to output estimated from long samples would converge to one. In the sample used here, the investment to GDP ratio shows a slight upward trend; hence the estimated elasticity is higher than one. When the regression is extended to also include the price of investment goods relative to the GDP deflator, we obtain a coefficient higher than one for the real value added and of 0.5 for the relative prices. The restrictions for real value added and the relative prices of, respectively, 1 and -1, are rejected.

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Appendix I. The Productivity Impact of Imports: Overview of Evidence at the firm- and plant-level

article image
article image
Source: Author.

Appendix II. The Productivity Impact of Offshoring

article image
Sources: Author, Olsen (2006), and Winkler (2010).Short term impact through access to better and/or cheaper inputs. Long term impact is through the restructuring i.e., changes in factor shares.
1

Prepared by Jean-Jacques Hallaert (EUR). The author thanks Edward Gardner (IMF), Antoine Berthou (Banque de France), Pierre Gaudin (Ministry of Finance) and the participants to the Seminar organized by the French Treasury on May 9, 2014 for their comments.

2

For more details on France competitiveness, see the Staff report for the 2012 Article IV Consultation (Country report No.12/342) and Hallaert (2013a).

5

Table 1 does not report cross-country studies on imports as a source of transfer of technology such as Coe and Helpman (1995), Coe et al. (1997), Eaton and Kortum (2001), Keller (2000), or Xu and Wang (1999).

6

Caution should be used when analyzing the 2009 decline. 2009 is the year of the “great trade collapse.” In part due to the development of GVCs, the elasticity of international trade to GDP was much larger than in previous recessions.

7

The difference is foreign value added embodied in exports. It is considered in gross exports but not in exported domestic value added.

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Cover IMF Staff Country Reports
France: Selected Issues
Author: International Monetary Fund. European Dept.
Volume/Issue:
Volume 2014: Issue 183
Publisher:
International Monetary Fund
ISBN:
9781498304023
ISSN:
1934-7685
Pages:
32
DOI:
https://doi.org/10.5089/9781498304023.002

France: Business Investment during the Crisis

France: Profit Margins

France: Confidence and Uncertainty Indicators

France: NFCs’ Financial Conditions

Business Investment in France: Actual and Fitted Values

France: Business Investment and Contributions

France: GDP and Investment Projections

(In index number, 2008Q1=100)