The role of uncertainty in private investment: the case of Malaysia

This study investigates the effects of uncertainty on the investment decisions at the aggregated and firm level (for a sample of 383 Malaysian firms). It is not the aim of the study to revisit the already well explored investment theories; instead, the study seeks to bridge the “disconnect” between conventional investment theory and empirics. The ability of empirical investment literature in explaining investment behaviour has been generally disappointing because of the theoretical constraints and the difficulty in isolating the forces which affect investment behaviour (Caballero, Engel and Haltiwanger, 1995). And this is further aggravated by data measurement problems. In spite of the empirical challenges, the importance of investment to economies in terms of expanding the productive capacity, generating income and employment, continues to be the primary motivation for this study. In the case of Malaysia, investments by the private sector contributed 1.6 percentage points to Gross Domestic Product (GDP) growth in 2011. The spirit of the study is therefore investigative, probing for answers that can explain the investment behaviour; the empirical models are used mainly as vehicles to construct, present and explain the relationship of the determinants of investment in a manner consistent with theory. The study leverages on the micro foundations of the neoclassical investment theory and specify both the macro and firm-level investment models that analyse the effects of uncertainty on irreversible investment. In doing so, the findings from this study will provide greater clarity on how investment responds to prices and shocks, resulting in better targeted investment policies. This study uses the Generalised Method of Moments (GMM) estimation technique for both the macro and firm-level investment models as this method addresses the problem of endogeneity. The significance of the negative signs estimate for macroeconomic and firm specific uncertainties suggests that uncertainties weaken the response of investment to demand thus slowing capital accumulation and is consistent with the predictions of theory. In addition, the structure of the economy and the depth its financial system determine the size of the impact of the macro uncertainties. The firm-level analysis corroborates with the findings from the macro model, however, the effects of firm-specific uncertainties are stronger for firms that cannot reverse investment decisions and for those with greater market power. The results suggest that public policies directed at encouraging investments should be more broad-based. While there is still scope for both monetary and fiscal policies, some attention should also be given to managing the perception of risks. As such, consistent and transparent public policies are critical in order to maintain credibility which collectively has important implications on expectations and risks. Policies which promote competition in goods markets and deepen financial markets are important as they allow firms to enhance efficiency and diversify risks. However, the steps taken to develop the financial sector must be measured against the risks of it becoming a potential source of instability. In short, the findings of the study answer the three research questions posed in the study. Broadly, the findings suggest that the government should complement its investment incentives with policies which emphasize on the stability and sustainability of the growth process. Experience of many countries has shown that, when appropriate policies and incentives are in place, a dynamic private sector is the most effective engine for long-term economic growth.