The Role of Firm Investment in Shrinking the Economic Freedom Index
The present paper explores why firm investment is sensitive and negatively correlated with financial equity. Furthermore, it is also seen that the effect of financial equity on firm investment is rather insignificant for medium information asymmetric firms. Finally, the present paper concludes by examining the implications of financial equity for firm growth. All these measures were taken take after conducting a detailed survey of different firms.
For firms with increasing level of domestic credit, greater degree of foreign portfolio, and external finance, firm investment appears to be sensitive to changes in fiscal policy. However, for medium firms, fiscal policy plays only a minor role in affecting firm investment decisions. There are some suggestions to improve fiscal policy transparency, but none of these suggestions seem to have a significant effect on firm investment decisions.
The present paper discusses the role of fiscal policy in affecting domestic credit markets. We begin by reviewing the evolution of the domestic credit market during the past two decades. We then analyze the reasons why fiscal policy has become more restrictive in the early part of the decade and why it became more flexible in the later part of the decade. We then review the implications of changing fiscal policy on investment decisions of domestic firms. Finally, we discuss three indicators to identify potential sources of fiscal restraint.
On the one side, the argument for restricting fiscal policy is that domestic firms need to adjust to external finance constraints as quickly as possible to avoid damaging their economic freedom. Since more firms are becoming less competitive over time, there is an increased risk that domestic firms will not be able to adjust to the new external financing conditions. Moreover, over the medium to long term, the loss of economic freedom is likely to be more costly than the associated cost of increased investment. On the other hand, the argument for allowing fiscal policy to adjust is that external financing constraints can affect domestic monetary policy. If, for example, interest rates rise above a certain level that causes firms to stop investing, the ensuing reduction in investment capital will reduce long-term growth.
To understand the relationship between financing obstacles and capital freedom, it is useful to first look at the conceptual framework by which capital flows are determined. Cash flow, in monetary terms, refers to the total value of all cash-flow transactions, which includes receipts (such as purchases) plus equity, net worth, and net worth plus capital payments (such as loans). In the model, capital flow is a function of time preferences with elasticity of substitution. Time preference refers to the tendency to save money as opposed to spending it. Capital, on the other hand, is a sum of many different effects that may be either beneficial or harmful to any particular firm.
One important effect of capitalization structure is the impact of depreciation on the economic growth. A higher capitalization index lowers the elasticity of capital investment, which lowers economic growth. Capitalization also affects savings, output, employment, and consumption. A key result of this process is the change in savings as output increases. This lower economic growth lowers the real value of investment, which lowers the economic freedom index.