Inactions and Spikes of Investment in Ethiopian Manufacturing Firms: Empirical Evidence on Irreversibility and Non-convexities

This paper provides empirical evidence on the effect of irreversibility and non-convexities in adjustment costs on firm investment decision based on 1996-2002 firm level data from the Ethiopian manufacturing. It relies on a rich census based panel data set that gives the advantage of disaggregating investment into different types of fixed assets. We document evidence of a large percentage of inaction intermitted with lumpy investment, which is consistent with irreversibility and fixed costs but not with the standard convex adjustment costs. The inaction is higher and investment lumpier for small firms. We complement the descriptive analysis with two econometric methods: a capital imbalance approach and a machine replacement model. With the capital imbalance approach we estimate the investment response of firms to their capital imbalance using a non-parametric Nadaraya-Watson kernel smoothing method. With the machinery replacement approach using a proportional hazard model that takes unobserved heterogeneity into account, we estimate the probability of an investment spike conditional on the length of the interval from the last investment spike.

Key words: Investment, irreversibility and adjustment costs, manufacturing, Ethiopia

JEL-Classification: C14; E22; O12; N67

UNU-MERIT Working Papers ISSN 1871-9872