GLOBAL BUSINESS AND THE MULTINATIONAL FIRM

Global Business and the Multinational Firm

Global Business and the Multinational Firm

Introduction

There has been a surge in interest in applying panel unit root and panel stationarity tests to examine the stationarity properties of energy consumption (see Lee, 2005; Al-Iriani, 2006; Narayan and Smyth, 2007 P.K. Narayan and R. Smyth, Are shocks to energy consumption permanent or temporary: evidence from 182 countries, Energy Policy 35 (2007), pp. 333-341.Narayan and Smyth, 2007; Chen and Lee, 2007; Hsu et al, 2008; Joyeux and Ripple 2007; Lee and Chang, 2008). Interest in whether energy consumption is stationary is motivated by several factors. First, if energy consumption is stationary, shocks to energy consumption will be temporary; however, if energy consumption contains a unit root, shocks to energy consumption will have permanent effects. Second, if shocks to energy consumption are permanent, given the importance of energy to other sectors in the economy, key macroeconomic variables can be expected to inherit that non-stationarity. As Hendry and Juselius (2000) note, “variables related to the level of any variables with a stochastic trend will inherit that non-stationarity, and transmit it to other variables in turn”.

Specifically, if energy consumption contains a unit root, through the transmission mechanism to real income, real output can be expected to contain a unit root. To consider this point in more detail, following the approach in Hamilton (2007), a simple framework for examining the relationship between energy consumption and real income is to consider a production function relating output (Y) produced by a firm to inputs of labour (L), capital (K) and energy consumption (E):

Y=F(L,K,E)

If output is sold for a nominal price of P dollars per unit, labour is paid a nominal wage W, the nominal cost of energy is Q and capital is rented at a nominal rate r, the profits of the firm can be calculated as follows:

PY-WL-rK-QE

A price-taking, profit-maximizing firm will purchase energy up to the point where the marginal product of energy is equal to its relative price

FE(L,K,E)=Q/ P

where FE(L,K,E) denotes the partial derivative of F(•) with respect to E. Multiplying both sides of the equation by E and dividing by Y one gets

This suggests that the elasticity of output with respect to a given change in energy consumption can be inferred from the dollar share of energy expenditure in total output.

Third, whether key macroeconomic variables are stationary has important implications for alternative economic theories, which suggest different conclusions on the issue of the desirability and efficacy of government intervention through the use of macroeconomic stabilization policies. If there is a unit root in real output, it suggests that following a negative shock automatic return to a normal trend may not occur, and, therefore, Keynesian stabilization policies to stimulate demand and move the economy towards full employment have a role to perform (Libanio, 2005). Alternatively, if real output is stationary, stabilization policies will be ineffective as output will revert to a natural rate, meaning Keynesian policies may only have temporary effects on output levels (Chang et al, ...