The relative price of equipment and the role of policy distortions in Latin America

This paper investigates to what extent policy distortions drive cross-country differences in the relative price of equipment for sixteen Latin American countries from 1960 to 2005. There is an extensive literature that studies the impact of capital accumulation on growth. Furthermore, a number of papers highlight the role of equipment as a “carrier” of new technology (DeLong and Summers (1993), Jones (1194), Mazumdar (2001)). Because of its role in capital deepening and technology diffusion, equipment is likely to be an important source of growth. In many developing economies, however, a barrier to acquiring equipment is its high relative price. Policy distortion can significantly raise this barrier and stunt equipment’s beneficial economic effect.

Existing empirical approaches have had limited success in identifying the impacts of policy distortions on the relative price of equipment. More specifically, the literature has had difficulty disaggregating investment into separate equipment versus structures series. Our paper utilizes observations from the Annual Statistical Yearbooks of Latin America, which provides data on both components of investment-equipment and structures- as well as their nominal and real values. We derive each country’s equipment price index over time by calculating the nominal equipment value and dividing it by the real equipment value (all relative to the consumption price index).

Using the constructed series on the relative price of equipment, we examine three topics: (i) the substantial fluctuations in the relative price of equipment across countries and over time in Latin America between 1960 and 2005; (ii) whether policy distortions are associated with a higher relative price of equipment; and (iii) whether policy distortions have an independent and direct effect on investment decisions or whether policy distortions impact investment only indirectly through their effect on the relative price of equipment. We estimate our model using system GMM first proposed by Arellano and Bover (1995) and Blundell and Bond (1998). This estimator allows us to account for autocorrelation in our panel data as well as the endogeneity of many of our explanatory variables.

The preliminary evidence shows that higher government expenditures and tariff rates increase the relative price of equipment, while financial openness, increases in the terms of trade, more developed financial markets, and increased government transparency all lower the relative price of equipment.