Public Policy, Price Distortions, and Investment Rates

Differences in the relative price of investment over consumption goods across countries are big, even after excluding non-tradable consumption goods. We interpret these differences as arising from differences in a wide range of policies that increase the cost of investment. Under this interpretation, we measure investment distortions using Summers and Heston's data and show that this measure is negatively correlated with investment rates and income per worker in a cross section of countries. We show that the steady state relation between relative investment distortions and relative investment rates predicted by a standard growth model closely resembles what we observe in the data. Moreover, simulations of a calibrated version of the model in which distortions follow a stochastic process common to all countries account for around 90% of the final disparity in relative investment rates. The model, however, cannot account for the disparity in income across countries and its evolution over time.