A Note on the Variability of the Replacement Investment Capital Stock Ratio

Abstract

Recent studies at both the theoretical and empirical levels (Feldstein and Rothschild, 1974, Nickell, 1975, Feldstein and Foot, 1971, Eisner, 1972 and Bitros and Kelejian, 1974) have offered accumulating evidence inconsistent with the neoclassical investment theory assumption that replacement investment is a constant fraction of the capital stock.' While this assumption was accepted largely on theoretical grounds, with renewal theory implying in the long run (given capital growing at a constant rate) that replacement investment will approach a constant proportion of capital stock, Feldstein and Rothschild have recently presented a series of contrasting theoretical arguments that suggest that it is likely to be untenable. To date, the most conclusive set of empirical results in support of this view has been Bitros and Kelejian's (hereafter B-K) analysis using annual data for the U.S. electric utility industry for the period 1946 to 1971. Unfortunately, the B-K analysis is subject to several important problems which involve the measurement of capacity and the nature of the electric utility industry.2 The purpose of this paper is to re-examine the B-K results, accounting for each of these issues. Given the importance of the proportionality assumption of neoclassical investment theory (particularly in the development of capital stock and user cost series), a reconsideration of the B-K evidence is warranted. Section II briefly reviews the B-K model, data, and results. The third section outlines each of the problems with their analysis. In section IV we present estimates of an amended version of their model using a relatively homogeneous component of the electric power industry, class A and B privately-owned firms for the period 1946 to 1971. Furthermore, we test this model for specifications errors and compare our findings with those of B-K. The last section summarizes the results.