Re: [OPE-L] J Winternitz's "The Marxist Theory of Crisis" online

From: Gerald_A_Levy@MSN.COM
Date: Thu Dec 23 2004 - 10:21:12 EST

Michael P,

Thank you for forwarding the section of your book on Keynes re
_Empirical Limits to the Study of the Replacement Investment_.
I think it was a very good critical survey of the literature on the
importance of  and problems associated with empirically measuring
replacement investment.

Did you, though, forward the _wrong_ section of that book?

I ask that question since the section you sent does _not_ seem to
support the conclusion that "the empirical evidence is that replacement
investment does take place more vigorously during downturns,
when competitive pressure is strongest."    Rather, as the title
suggests, it explains the empirical _limits_ to the study of that
subject.  Indeed, this entire section could be read as a caution against
drawing _any_ 'stylized facts' from the empirical data because of the
many measurement and definitional problems with the very incomplete
and unsatisfactory data which is available (some of those problems
are excerpted below).  While there are useful and interesting
microeconomic examples of replacement investment -- unless I have missed
something -- there is no assertion one way or the other by you
based on macroeconomic data that the pace of replacement investment
occurs more rapidly during contractionary periods.

In solidarity, Jerry

The exact nature of the replacement decision should be a matter of
interest for those who frame economic policy, especially considering the
lip service paid to economic modernization. Yet, despite the elegant
mathematical tools and the extensive data bases available to economists,
we know astonishingly little about actual replacement practices.
The difficulty of pin‑pointing the act of scrapping adds a further
complication to the analysis of replacement investment.
For the aggregate economy,
replacement of capital goods is not equivalent to retirement. Many
capital goods find their way to second‑hand markets. Plant and
equipment, no longer used for their original purpose, are frequently put
to other uses or worked less intensively (Foss, 1981a, 1981b and 1985).
The inclusion of the multitude of options for redeploying replaced
capital goods blurs the boundaries between replacement and expansion.
For example, British firms report difficulty in distinguishing the
replacement from improvements in technique (Barna, 1962, p. 31).
Even when old capital is no longer actively used, it may continue to
serve as an inventory of capacity to meet possible future peak load
needs (Oi, 1981).
Firms may hold what appears to be excess capacity one moment only to
face backlogs the next (De Vany and Frey, 1982; see also Steindl, 1976,
p. 8). The incentive to use capital rather than labour to meet sudden
increases in demand depends, in part, upon the ratio of capital costs to
labour costs. For example, in the textile industry where labour is a
relatively small fraction of total costs, surges in demand tend to be
met by increasing labour inputs rather than capital. By contrast, in
coal mining where labour costs are relatively high, industry meets
demand shocks by moving pits on‑ and off‑line (Rowe, 1928, pp. 10‑2).
In addition to the complications associated with the various
possibilities for replacing obsolete capital goods, the common empirical
measures of the existing capital stock are seriously flawed. Until
recently, imported capital goods were not included in the measures of
current investment in the US.
Although economists are trained to count in terms of monetary values,
satisfactory monetary values are often unavailable except for newly
purchased capital goods. Once capital is installed, indicators of its
value become increasingly unreliable. Accepted accounting practices are
almost entirely based on cost rather than the actual values of installed
plant and equipment (Beidleman, 1973, p. vii). Thus, accounting values
bear little relationship to the actual economic values (Beidleman, 1976;
F.M. Fisher and McGowan, 1983) unless depreciation rates track the
actual economic deterioration of plant and equipment. To construct such
depreciation formulae is all but impossible. It would require the
relative values of two vintages of machines to be independent of
changing price ratios.
Even if such depreciation formulae could be devised, they probably would
not be used. Allowable depreciation is determined as much by political
as economic considerations. The book value of much of the old plant and
equipment will tend to be insignificant, having been either all, or
mostly depreciated away. Such discrepancies are of major importance in
the study of scrapping.
Government estimates of capital stocks are unsatisfactory. They are
constructed on the basis of the perpetual inventory method, which
determines the capital stock each year by adding the difference between
the value of new investment and an estimate of the annual depreciation
of existing capital goods. Unfortunately the assumed pattern of
depreciation is based on a predetermined economic life for each category
of investment goods, usually based on Bulletin F of the Internal Revenue
Service (first published in 1931) or Winfrey's 1935 study, developed
from mortality curves compiled by workers at the Engineering Experiment
Station of Iowa State College during the 1920s and 1930s (Winfrey,
1935). The capital is then assumed to depreciate according to some fixed
pattern, such as double‑declining balances or straight line depreciation.
The estimated lifetime of capital introduces further bias in the
aggregate depreciation figures.
An error of one‑third in the assumed
asset life of capital alters the estimated size of the capital stock by
about one‑third (Redfern, 1955, pp. 142‑7). The economic lives used for
tax purposes often are unrelated to the actual economic lifetime of the
plant and equipment. By the time a machine tool is scrapped, three
entire generations of tools can be written off (Beidleman, 1976).
Feldstein and Rothschild note that the basis for the 1942 edition of
Bulletin F lives was never published, although the estimated lives were
based on Winfrey's work, as well as conferences with industry and
statistical studies (Feldstein and Rothschild, 1974). Even so, these
estimates of capital goods lives are not sufficient. For example,
Hickman questioned the accuracy of Bulletin F, speculating that the
standard of obsolescence applied during the 1930s was atypical because
plant and equipment might be less readily scrapped during a depression
(Hickman, 1965, p. 241). In fact, a depression may actually shorten the
life of capital goods, creating more incentive for scrapping and less
for the renewal of plant and equipment (Boddy and Gort, 1971; and
Eisner, 1978, p. 182).
In effect, the permanent inventory method of calculating capital stock
suggests that the retirement of capital is a wholly technical decision,
unaffected by prevailing economic conditions. It presumes that no matter
what sort of shocks occur, the relative prices of different vintages of
capital goods will remain unaffected. The weakness of such assumptions
is obvious. You do not have to be a firm believer in the Kondratieff
cycle to suspect that technical change does not always evolve regularly,
but often seems to come in spurts. Sometimes it will be concentrated in
specific industries. At other times, it will be more evenly distributed
among industries. In addition, capital decays faster when it is utilized
more intensively (Keynes, 1936, pp. 69‑70; Marx, 1977, pp. 527‑9).
Certainly statistical evidence indicates that failure rates do rise with
capital use (Davis, 1952; Jorgenson, McCall and Radner, 1967).
Are we to believe that capital equipment is kept in operation for a
fixed period of time, regardless of the prevailing long‑run
macro‑economic conditions? Otherwise, the permanent inventory procedure
is unjustified for estimating both the capital stock and models of
investment. Yet every empirical study of which I am aware suggests that
the capital stock decays irregularly. Most observers agree current
economic conditions affect the scrapping decision.
The decision to scrap a vessel will depend very greatly on anticipated
movements of freight rates and the rising trend of repair costs with
increasing age ... A sudden increase in the demand for tonnage at a time
when new building cannot be increased is likely, therefore, to give rise
to some postponement in the scrapping of those types of tonnage in
demand, almost irrespective of age. (Parkinson, 1957, p. 79)
Ryan found that in the Lancashire cotton industry between 1860 and 1838,
38 per cent of the machinery replacements occurred in the boom years
1906‑1908, 1912‑14, and 1919‑21 (Ryan, 1930, p. 576). Feldstein and Foot
wrote: 'Expansion investment causes an offsetting fall in replacement
investment, supporting the view that firms postpone replacement during
periods of expansion investment and accelerate replacement when there is
less expansion investment' (Feldstein and Foot, 1971, p. 54). This
conclusion must be taken with a grain of salt, based on the justifiable
criticisms of their estimates by both Jorgenson and Eisner (Jorgenson,
1971, p. 1140; Eisner, 1978, pp. 175‑88), which I will discuss later.
The unsatisfactory measures of the capital stock substantially
complicates the analysis of replacement investment.
The figures shown in Table 3.1 are far from perfect. They depend upon
voluntary information based on the book values of capital goods
Although considerable information is collected regarding aggregate gross
investment, scrapping rarely leaves a satisfactory paper trail.
In the absence of any useful public data base, researchers depend on
access to private records.
Terborgh suggested that purchasing capital goods is akin to
participating in a futures market for capital services (Terborgh, 1949,
p. 29). A hypothetical futures market for capital services differs from
actual futures markets since spot markets for capital services do not
generally exist. Futures markets typically develop for widely traded,
homogeneous commodities. Most capital services, or even capital goods,
are neither widely traded nor homogeneous. Existing futures markets are
difficult enough to predict, but the hypothetical futures market for
capital services would be even more complex.
If firms have a high liquidity preference, they will hoard their money.
Sellers of capital goods will have to lower their price to entice other
firms to part with their funds. Future values of capital services,
reflected in the values of newer capital goods, will be very low
relative to the value of current capital services.

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