[OPE-L:6514] Re; Obsolesence

John R. Ernst (ernst@PIPELINE.COM)
Mon, 27 Apr 1998 02:02:44 -0400 (EDT)

Continuing my exchange with Allin.

Allin wrote:

To return to John's original example:

> "Let's take an example. Suppose that the annual cost for the
> stock of circulating capital is $6000 -- $5000 in constant capital
> and $1000 in variable capital. The output produced at the end
> of each year sells for $7000. If the fixed capital is
> fully depreciated, then the return on this investment would be
> 1000/6000 or 1/6."

Allin wrote:

OK, I agree that if you have to put up $6K at the start of the
year and don't get the $7K revenue till the end, then this
process can't compete with a new technology offering a 20% rate
of return. The present value of the old, fully depreciated,
capital stock is then -6 + 1/(1.2) + 1/(1.2^2) + ... < 0.
"Can't compete", in the sense that a rational capitalist with
ready access to funds would prefer to scrap the old plant and
invest in the new technology, rather than continuing to put $6K
per year into operating the old.

John comments:
It's good to see that we have some agreement here. Prior to
considering your questions below, let's consider the case where the
older fixed capital is not fully depreciated. That is,(1)if the
RRI on this old technique is, say, 10% as it is used and depreciation
takes place and (2) if the new technique with an RRI of 20% becomes
available prior to recovery of the original investment, then
the old technique is still unable to compete. Put another way, by
setting the fixed capital of the older technique at 0, we obtain
the maximum rate of return that can be achieved with the process.
In my example, it was 1/6. To achieve a greater rate, the value
of the fixed capital must become negative. Capitalist rationality
requires its abandonment. Of course, I agree with your comment that
moving to the new technique may require funds that the capitalist
does not have and cannot borrow.

Allin wrote:

At a zero discount rate, -- or a modest rate reflecting the real
growth rate of the economy -- however, it would make sense to go
on operating the old plant. Is that, in effect, what you were
saying would be the socially rational decision?

John answers:

Yes. If fixed capital has a natural life of, say, 10 years and is
abandoned after,say, 6 years in the above case, then at most 4 years of
its life appear wasted. I say "at most" since one also has to assume
that costs are at least covered for the four year it could function
with fully depreciated fixed capital.

Allin wrote:

As an empirical matter it would be interesting to know: How
common is it for old processes to get into the position
represented in your example, i.e. where the present value of the
fully depreciated means of production goes negative, when
discounted at the current rate of return, yet the process is
still capable of generating positive operating profit? (I
suspect it may be rare.)

John writes:

Your contention is that when the present value of the fixed capital
turns negative the process generally is not capable of generating
positive operating profit. I suspect that you're generally right
if output prices are falling relative to input prices. If the
opposite is the case, then we may see inflationary profits in
addition to the $1K that we have in the example.

In the case where an operation is abandoned and handed over to the
workers for a nominal amount, we probably have a case where the
process is generating positive operating profit. How to keep
such an operation running when the plant and equipment become
physically useless is the problem. Accumulating those profits
would generally not be sufficient to purchase new plant and
equipment. Indeed, if they are, the workers would not "own"
the operation.