A DYNAMIC MODEL OF CAPITAL INVESTMENT IN NEW ZEALAND. A.W. Smith Ministry of Works and Development Wellington N.Z.

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Summary The Development and Programming Branch of the Ministry of Works and Development is developing a series of dynamic models so that: (1) The allocation of investment funds in a particular sector

1 76 A DYNAMIC MODEL OF CAPITAL INVESTMENT IN NEW ZEALAND A.W. Smith Ministry of Works and Development Wellington N.Z. Summary The Development and Programming Branch of the Ministry of Works and Development is developing a series of dynamic models so that: (1) The allocation of investment funds in a particular sector can be better related to other sector activity, total consequences, and longer term goals. (2) Potential constraints and other adverse outcomes can be more readily identified in time to take less disruptive corrective action. (3) The likely impact of new projects, new policies, external factors, and recommended solutions can be more thoroughly investigated. (4) The most sensitive factors can be more readily identified so that flexibility can be maintained, instability can be reduced, and certain exogenous variables in more specific models can be defined with a greater degree of confidence. The particular model described in this paper is being used to identify the likely consequences of pursuing particular investment programmes. The description is limited to the basic structure of the model and the definition of the basic elements.

77 1. Basic Structure The structure of the model follows the general requirements of the DYNAMO simulation language developed by Prof. Jay Forester at M.I.T. (1,2).

During a specified time interval the facilities available are increased by the addition of completed works and reduced by demolitions, obsolescence, etc.

2 77 1. Basic Structure The structure of the model follows the general requirements of the DYNAMO simulation language developed by Prof. Jay Forester at M.I.T. (1,2). At any particular point in time there is a certain quantity (level) of constructed facilities available and another quantity (level) of facilities under construction (refer figure 1). During a specified time interval the facilities available are increased by the addition of completed works and reduced by demolitions, obsolescence, etc.. Likewise the facilities under construction are increased by the new works started and reduced by actual completions. Demolitions, etc., are calculated as a constant proportion of the facilities currently available and the completion rates are determined by previous construction rates and the capabilities of the construction industry. The capability of the construction industry is represented by the average completion time for a particular type of work, which in turn depends on the availability of construction labour and materials. In this particular model, the construction rates are determined solely by the availability of investment funds for this purpose. The availability of funds for additional works is determined by a particular "client's" desire for these works in relation to their current cost, his financial commitment and the total funds at his command.

Other Private WORK PROGRESS CONSTRU. RATE add. funds avail. invest, funds reqd.

3 78 Figure 1 - Basic Structure SECTORS Urban Farm Logging Mining Manufact. Transport Electric Supply HEW Comnerce Construction Other Govt. Other Private WORK PROGRESS CONSTRU. RATE add. funds avail. invest, funds reqd. availability of constru.mats Sector Funds avai1. Domestic Prices Sector demand CONSTRU'D FACILITIES AVAILABLE availability of constru.lab DEPREC RATE Add. facil. reqd.

efore, the demand for construction services has been subdivided into its "sector" components, i.e., the demand for developed land (rural and urban), dwellings, other agricultural facilities, logging,

4 79 Obviously these factors will vary from client to client, as will the construction industry's produce these works. capacity to Therefore, the demand for construction services has been subdivided into its "sector" components, i.e., the demand for developed land (rural and urban), dwellings, other agricultural facilities, logging, mining, and manufacturing facilities, transport facilities (as distinct from transport vehicles), electric supply facilities, health-education-welfare, commerce, construction, other government and other private facilities. The model shown in Figure 1 has 5 sets of exogenous variables and 2 "feedback" loops. Feedback is illustrated by the fact that the current requirement for investment funds depends on the financial requirement for works in progress and therefore on the previous avilability of investment funds and therefore on the previous requirement for investment funds. Any model which ignores this sort of feedback runs the risk of departing very quickly from the real world situation, but how far must we go with these feedback assumptions? The answer,it seems, lies in another question: To what extent do any of the exogenous variables in our basic model depend on any of endogenous ones? - bearing in mind the purpose of the model, and our desire (in this case) to investigate the impact of various investment decis ions. Perhaps this process can be best illustrated by referring, first, to the availability of construction labour (Figure 2).

5 80 Figure 2 - Availability of Construction labour fertility rate immigration policies

maintenance of existing facilities. On the other hand, the availability of construction labour will depend on the demand in the other sectors too.

6 The Availability of Construction Labour The requirement for this resource will depend on the level of construction activity, represented, perhaps, by the annual expenditure on new works and maintenance of existing facilities. On the other hand, the availability of construction labour will depend on the demand in the other sectors too. To the extent that this is likely to be significant we should derive it using the sector breakdown previously described. Obviously,there is an overall limit to the labour available depending on the size of the population. We may treat the rate of population increase as exogenous or, since we are concerned with development decisions, distinguish the immigration rate from the natural increase. We are now faced with determining the distribution of the labour force. If the total available exceeds the total requirement we have no immediate problem. If the total labour available is less than the total requirement, we have assumed that it will be distributed amongst the various sectors according to their relative requirements. The validity of this assumption can only be confirmed by checking with historical data. Thus we have replaced one exogenous variable (the availability of construction labour) with several endogenous variables and two other exogenous variables (the fertility rate and the immigration rate). Other sector labour requirements also remain exogenous at this stage.

7 Figure 3 - Availability of Construction Materials 82

83 3. The Availability of Construction Materials As before the requirement for construction materials depends on the level of construction activity, but in this case the availability depends on the

$exports. Again, since this model is concerned with investment decisions, we have assumed that a certain fraction of the domestic demand is to be produced in New Zealand.$

8 83 3. The Availability of Construction Materials As before the requirement for construction materials depends on the level of construction activity, but in this case the availability depends on the production as well as the requirements of the other sectors (see Figure 3). Ultimately, the availability of construction materials depends on the availability of imports, in association with the total demand for all types of other sector output, including the demand for exports. Again, since this model is concerned with investment decisions, we have assumed that a certain fraction of the domestic demand is to be produced in New Zealand. Besides determining the normal volume of imports required, this concept makes it possible to identify a "desirable" production of other sector goods (intermediate goods as well as finished goods), which then becomes the key factor in determining the additional facilities required, the other labour required and the actual production of intermediate and finished goods, including construction materials. Actual production may be limited by the availability of production facilities, and other labour, as well as specific production policies. In the final outcome the availability of goods for construction purposes is determined by current export/import policies and current stocks as well as the actual production and the demand from the other sectors. In this instance we have replaced one exogenous variable (the availability of construction ma t erials), with several endogenous variables and eight exogenous ones, and gone a considerable way toward identifying the sector components of the demand for construction services, and the source of investment funds.

Although export/import prices remain exogenous some attempt must be made to determine domestic prices within the model, because these in themselves may be directly related to the availability of

9 84 4. Investment Funds Available Up till now we have been dealing with physical quantities of facilities, labour, goods etc. In order to identify the availability of investment funds for particular purposes we must now take account of actual (or expected) prices for facilities, labour, goods,etc.-. Although export/import prices remain exogenous some attempt must be made to determine domestic prices within the model, because these in themselves may be directly related to the availability of facilities, labour, goods, etc.. With a knowledge of prices, economic policies, export/import and employment levels, it is possible to calculate domestic incomes and expenditures; to modify the existing economic policies if so desired; and identify the sector funds available for construction purposes. The basic information flows associated with this aspect of capital investment in New Zealand are summarised in Figure 4 which also includes the other information flows summarised in Figures 1 to Using the Model Figure 4 illustrates the wide range of factors which seem likely to influence the performance of the construction industry. Conversely, it illustrates the wide range of factors which seem likely to be influenced by; the performance of the construction industry.

10 85 Figure 4 - Basic Information flows Other develop' policies desired prod, of other *- goods Service Constn. work in progress Constrd facil. avail. invest funds avail. invest funds / reqd domestic incomes expend total $ lab. employed availability of lab. ^ materials domestic / 7 ^production--- ' of other goods services' other res. avail. stocks of consumption goods imports, exports domestic I consumption of other goods 5 services production policies import export policies

86 On top of this, it illustrates the degree of feedback involved in investment decisions, and as such, it 'documents' a number of theories about the investment process.

In order to do this we need initial values for the population, facilities, stocksjetc., and some idea of the initial distribution of labour, production, investment funds, etc.

11 86 On top of this, it illustrates the degree of feedback involved in investment decisions, and as such, it 'documents' a number of theories about the investment process. Confirmation of these theories depends largely upon our ability to reproduce the relevant historical development in New Zealand over a reasonable period of time. In order to do this we need initial values for the population, facilities, stocksjetc., and some idea of the initial distribution of labour, production, investment funds, etc.. We need actual values for the exogenous variables, and a suitable definition of development policies (see Figure 5). With this particular information it has been possible to reproduce the general pattern of development since 1968/69 within a few percent of the recorded values. The model has been used to investigate the likely impact of particular investment programmes on employment and imports in particular, and is currently being used to identify the most sensitive variables and those areas most likely to be effected by external factors. References 1. Forrester, J.W. Industrial Dynamics, MIT Press, Pugh, A.L. Dynamo II User's Manual MIT Press, 1974.

$, we need suitable definitions of: Other development policies - relating in particular to - the natural increase of the New Zealand population - net migration - the fraction of domestic$ demand to be produced in New Zealand - the distribution of physical resources - the government's participation in the development process Various production policies - relating in

demand to be produced in New Zealand - the distribution of physical resources - the government's participation in the development process Various production policies - relating in

12 87 Figure 5 - Policy Definitions Required Apart from specific investment policies relating to housing, education, electric supply, etc., we need suitable definitions of: Other development policies - relating in particular to - the natural increase of the New Zealand population - net migration - the fraction of domestic demand to be produced in New Zealand - the distribution of physical resources - the government's participation in the development process Various production policies - relating in particular to: - export orders - stocking rates - planting rates - milling rates - exploitable reserves of natural resources Various economic policies - relating in particular to - tax rates - borrowing - trade deficits - the general availability of credit

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