The Optimal Direction of Firm Investment

In this paper the authors assess the rate of profit to firm fixed investment in the form of individual formal employment training. Their estimates of this profit to fixed investment vary widely across firms. On average it’s -4% for large firms not offering formal employment training and an average of 9% for medium firms that provide formal employment training. The authors then investigate the link between firm fixed investment growth and the quality of that training.

I argue that firm investments made in training are inefficient because (a) the returns are inefficiently captured through the firm-employee contract, (b) misvaluation-induced firms to divert resources away from the quality of production and (c) the allocation of resources to poor quality firms contributes to rising output misallocation. I further argue that, if misvaluation is a cause of industrial activity then the present regime under which public sector managers are prevented from using discretion should be changed to allow them to use discretionary decision-making tools such as the employment contract system. This would allow managers to properly allocate resources to boost firm investments in training and to respond to changing external incentives like increases in productivity and unemployment.

Looking first at the inputs/output costs of firm investments in training, I find that they are inefficient if the direct costs are included. Training input costs consist of salaries and wages paid to employees and indirect costs stemming from the misallocation of existing resources. I call these costs of misvaluation “miscellaneous expenses”. The largest single component of these “miscellaneous expenses” is the cost of using the employment contract system to allocate existing resources (e.g., between existing staff or between existing firms). I further add the cost of incentives to be added into the mix, specifically higher bonuses for those who have good performance, incentives for “good employees” and “exceeding customer expectancy”.

Under this alternative framework I then assume that firm investment decisions are made on imperfect knowledge. If firms take a random allocation approach then the outputs of their decisions may be biased due to imperfect knowledge. I call this “biased optimal allocation” assumptions. Under these assumptions, when firms make firm investment decisions then they use information that is both accurate and unbiased to reach their investment decisions.

Using these inputs to allocate the firm’s existing resources can be used as an economic tool to improve aggregate demand in the economy. This is because firms with the best inputs can serve as a source of demand elasticity. If firms have similar inputs then firms with differing existing output capabilities can serve each other’s needs if their existing output capability is high enough but not equal to other firms’.

To illustrate these inputs in a real life context let us say that firms exist in different industries with differing existing output capabilities. Let us then assume that firms A and B both produce capital goods while firm C does not. Firm A will purchase capital goods A because it knows it will earn more money from selling those goods to its customers than it will by making the capital goods itself. Firm B will sell its inventory of goods minus its own inventory to firm A. Firm A then uses its superior knowledge of the market price to realize its desired elastic demand.