Energy price changes and the induced revaluation of durable capital in U.S. manufacturing during the OPEC decade

Abstract

When energy prices increased suddenly and unexpectedly in 1973-74 and 1979-80, a portion of the long-lived capital stock in U.S. manufacturing was rendered economically less valuable. In this paper we develop an analytical framework, consistent with the theory of cost and production, that provides an appealing structural interpretation of this capital revaluation phenomenon.

In the spirit of a putty-clay model, we demonstrate that the capital -revaluation elasticity is the negative of the ex ante substitution elasticity between energy and capital equipment. The model is implemented empirically with annual data from U.S. manufacturing, 1958-81, and vintage investment data since 1929. Maximum likelihood estimation is undertaken with nonstatic expectations of future relative price values treated as an unobservable ariables problem.

Our principal empirical findings are (i) that the elasticity of capital valuation with respect to relative energy price increases -- the capital revaluation elasticity -- is between -0.234 and -0.543 in U.S. manufacturing, and (ii) that by 1981 the appropriately revalued capital stock is at least 13% less than traditional measures indicate. We also consider implications of capital revaluation for the measurement of capital-labor ratios, age-shadow price profiles, and vintage-specific Tobin's q's.