The Substitution of Capital for Capital

Abstract

A LTHOUGH homogeneous capital stocks remain a frequent construct in growth theory and the literature on production relations, economists have not missed the fact that trucks are not lathes. Thus considerable effort has gone into specifying the conditions under which aggregation is conceptually permissible.1 Recently, the aggregation of capital services from diverse capital stocks has become an important consideration in the explanation of productivity change for the American economy. Jorgenson and Griliches 2 note the rise in the ratio of equipment stocks to structures stocks over the period 1945-1965. They employ the presumed increase in aggregate capital services from the use of relatively shorter lived assets to explain about 25 per cent of the residual change in the measure of total factor productivity. But very little has been done thus far to identify those variables that exert major influences on changes in the composition of capital goods.3 This paper is directed toward a remedy for this deficiency. In assessing shifts in composition, we have two principal objectives. First, to determine (through the use of an investment matrix) the extent to which changes in the composition of aggregate investment arise from differential industry investment rates as distinct from changes in the coefficients of the matrix itself. Second, to ascertain the determinants of the shifts in aggregate investment, particularly the ratio of equipment to structures. We shall show that the relative prices of capital goods have not been among the principal determinants of such substitution. The theory and estimates of this paper ascribe the changes in composition to variations in the relative costs of capital and labor and to the shift of investment in times of capacity expansion toward new plants with higher ratios of structures to equipment outlays than those for existing plants.