He, Qi; (2024) Neoclassical Investment Theory and Evolution: Trend and Policy Intervention in the UK. Doctoral thesis (Ph.D), UCL (University College London).

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Abstract

This thesis reports three main findings within the neoclassical investment framework, providing a perspective on the evolution of capital investment. It begins by establishing a new method to measure marginal capital return. With this method, it reveals discoveries that the capital investment intensity has been declining in the UK over the last three decades due to diminishing investment returns. Furthermore, it shows from an example named Help to Buy (HtB) that a suitable policy intervention could help alleviate the sluggish investment and return trend. Measuring investment return has posed a significant challenge within the field. Chapter 2 delves into the key aspects of the challenges from a theoretical aspect. Building upon this review, I introduce a production function based method to calculate markup and elaborate on how it addresses the difficulty in observing the key variable of marginal Q empirically, which was previously constrained by its marginal and forward-looking mathematical nature. This method plays a key role in the study of the subsequent chapters. Assisted by the new metric introduced in Chapter 2, Chapter 3 re-examines the corporate investment pattern over the last three decades within British firms. It reports a notable finding regarding the investment-cash flow sensitivity (ICFS), a significant financial indicator of capital investment intensity, which has shown a declining trend among unquoted firms over the past three decades. This discovery corresponds to a new puzzle of the diminishing ICFS primarily discovered in the US. The study examines data from British firms and identifies asset tangibility as the primary factor influencing the ICFS, indicating that the ICFS is, in fact, an investment-cash flow-tangible capital sensitivity. The decline in investment in tangible assets emerges as the key driving force behind the diminishing ICFS. The sustained decline of capital investment over the last thirty-six years is a consequence of decreasing returns on tangible capital. This reduced investment activity leads companies to depend less on cash flow financing, resulting in a declining ICFS within the firms. These findings highlight the importance of addressing the issue of low capital returns for fixed assets, particularly in traditional, non-public firms heavily dependent on tangible assets. This thesis presents a remedy for the declining investment in Chapter 4 by probing the influential effects of a credit expansion policy, Help to Buy, on developers’ investments and finances. The study employs the HtB scheme as a quasi-random experiment and uses a Difference-in-Differences (DID) method to determine the policy’s causal effects. The research outlines a detailed cost-benefit framework that considers the pure demand shock brought about by the policy. It demonstrates that the policy has led to increased costs and sales for participating firms and has resulted in surplus profitability, against the backdrop of a general decline in capital productivity outlined in Chapter 3. Notably, it shows that the HtB scheme does not boost builders’ market power (as measured by markups). Instead, it promotes excess profitability by encouraging builders to sell more properties at relatively lower margins - margins that would have been higher in the policy’s absence. Lastly, the Q theory framework examination suggests that the policy has facilitated stable growth expectations for firms, substantially mitigating their adjustment and financing costs. This dynamic predominantly drives the observed higher profits and lower margins, facilitating continued investment and construction from developers. The HtB boosts homeownership from the demand perspective and provides financial advantages from the supply perspective, creating a profound impact on the British economic and social landscape. This could serve as a policy example for mitigating the general under-developed productivity issue studied in Chapter 3.

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