Many economic textbooks present firm investment as being an important factor behind successful firms in terms of profitability. However, very few economic journals have presented firm investment as being an important factor behind unsuccessful firms in terms of profitability. This gap in the literature has resulted in a split between those researchers who believe that firm investment is important and those who do not. The present article attempts to fill this gap by examining the importance of firm investment in terms of profitability for different firms in different industries.
Firm investment has been found to be quite relevant for large firms when controlling for firm size and number of employees. It is also seen that the effect of large firm investments on firm productivity is quite significant especially for medium information asymmetric industries. Further, the present paper further shows that the relation between firm investments and productivity is especially important for small-scale industries. This suggests that firms with limited human capital tend to be lagging behind large companies when it comes to productivity, as human capital is the main ingredient in creating and maintaining high levels of productivity.
One of the reasons why firm investment efficiency has been found to be a negative impact on competitiveness is that of excessive government intervention. The present paper proposes three explanations for this assertion. The first explanation concerns the way in which government interventions can increase firm costs through exogenous factors. Government interventions can do this through increased government regulation, higher taxes or introduction of price controls. The second explanation regards the manner in which exogenous factors such as technological change can decrease the attractiveness of a firm’s product or service relative to other similar products and services in the market. Finally, exogenous factors can also affect firms’ investments through government disbursement.
The third explanation regards the impact that disbursement of government funds may have on investment decisions. Disbursement may affect firms’ investment because of the possibility that some of these funds will be spent on unproductive endeavors, thereby reducing the firms’ overall efficiency. Specifically, if firms are required to invest a portion of their capital in order to keep the facility operating then they may choose to divert this capital to higher yielding ventures. Alternatively, if firms are required to divert all of their capital to expansion projects then they would be less likely to reinvest in their existing production processes and may choose to divert this capital to other areas, thereby decreasing their efficiency.
Overall, the present study provides evidence for both the positive and negative effects that increased government intervention can have on firms’ investment decisions. However, given that the costs of economic freedom are so high, as well as the likely negative effects of increased government intervention, it appears to be a very unrealistic proposition that greater governmental intervention would reduce firms’ investment. The only way in which economic freedom and economicefficiency can be achieved is through lessening the distortions that occur as a result of excessive external finance.
In conclusion, the present study serves as a reminder that fiscal policy, when directed towards optimal investment objectives, can have a powerful effect on firm investments. This is especially so when such policy is adopted in response to a severe global financial crisis period. Nevertheless, the present study also highlights the importance of proper monetary and credit policies even in times of economic recession or turmoil. The fact that fiscal policy was implemented during a period of economic turmoil is a clear example of how such policy can have a pro-inflation impact. Finally, it must also be noted that increased government spending can sometimes have adverse impacts on firms’ investment decisions.