Vintage Capital Research Articles

The Path to Energy Savings and CO2 Emission Reductions in China's Industrial Sector from the Perspective of Factor Price Distortions Correction - Based on an Extended Capital Vintage Model

Exploring the endogenous driving mechanism of CO2 emission abatement from the perspective of factor price distortions is crucial for China to achieve the goal of carbon peaking and carbon neutrality. Despite its importance, there is a notable gap in current research as existing studies have failed to open the "black box" of factor price distortions affecting CO2 emissions. In this paper, we construct an extended vintage capital model under the imperfect factor market scenario to shed light on the intrinsic mechanism by which factor price distortions affect energy demands and CO2 emissions through the dynamic accumulation of energy-efficient capital vintage. Subsequently, based on compiling a unique "province-industry-year" three-dimensional panel dataset (from 1998 to 2013), this research further endeavors to systematically assess the energy saving and carbon reduction potentials of correcting factor price distortions in China's industrial sector. The results show that correcting factor price distortions could save the industrial sector an average of 225 million tonnes of standard coal of energy and reduce 793 million tonnes of CO2 emissions per annum over the period of the study by promoting the energy efficiency of capital vintage. Additionally, rectifying factor price distortions can lead to significant synergistic effects in reducing atmospheric pollutants as compared to aquatic pollutants.

A DSGE model of energy efficiency with vintage capital in Chinese industry

As the conventional method for estimating the impact of energy prices on energy consumption, the reduced form approach creates a “black box” interpretation of the energy price-intensity relationship without identifying the channels, or their magnitudes, through which prices matter. This shortcoming is particularly serious for China that has multiple ownership types operating under different government policy regimes. To remedy this shortcoming, this paper formulates a dynamic stochastic general equilibrium (DSGE) model that incorporates a range of technology avenues – both embodied and disembodied – for achieving energy-savings in response to rising energy prices. Employing Chinese firm-level data, the paper recovers key parameters in the DSGE model by indirect inference; so the model can replicate the stylized facts based on the firm-level data. A key finding is that embodied putty-clay investment is a critical channel for achieving energy efficiency, on which SOEs most depend, non-state-owned enterprises depend less, and foreign-funded enterprises least depend.

Vintage capital and trade credit

AbstractThis paper examines whether and how capital age influences trade credit extended by suppliers. We find that firms with older capital are associated with a reduction in trade credit offered by suppliers, which is consistent with the view that vintage capital, with outdated technology, is detrimental to firms. Employee outside opportunity, labour mobility and organisational capital are important factors that moderate the association between capital age on trade credit. Our findings are not driven by specific industry sectors or periods and remain robust to alternative measures of trade credit and to endogeneity concerns. In addition, we show evidence that shareholders view vintage capital as value‐destructive. In sum, this study reveals that risk exposure associated with capital age matters for corporate trade credit decisions.

A Multisectoral Dynamic Model for Energy, Economic, and Climate Scenario Analysis

The MIT Economic Projection and Policy Analysis (EPPA) model has been widely used in energy, land use, technology, and climate policy studies. Here, we provide details of revisions that form the basis of EPPA7, the current version. Key updates include: 1) using the latest Global Trade Analysis Project (GTAP-power) database as the core economic data for the world economy; 2) updating regional economic growth projections; 3) separating extant and vintage capital of the previously aggregated fossil generation; 4) using an innovative approach to calculate the costs of backstop (i.e., advanced) power generation options based on engineering data from the Energy Information Administration; 5) identifying base year biofuel output from existing sectors; and 6) re-parameterizing electric vehicles based on recent studies. Our simulations demonstrate that with widespread mitigation policies worldwide, regions relying heavily on fossil fuel imports benefit from lower global fossil fuel prices when their domestic emissions targets are lenient, but the benefits dissipate when deeper emissions cuts are imposed domestically. We also provide an illustration how the model output can be used to calculate the net present values of unrealized fossil fuel production and stranded assets from idling coal power generation under various policy scenarios.

Young firms, old capital

Across a broad range of equipment types and industries, we document a pattern of local capital reallocation from older firms to younger firms. Start-ups purchase a disproportionate share of old physical capital previously owned by more mature firms. The evidence is consistent with financial constraints driving differential demand for vintage capital. The local supply of used capital influences start-up entry, job creation, investment choices, and growth, particularly when capital is immobile. Meanwhile, as suppliers of used capital, incumbents accelerate capital replacement in the presence of younger firms. The evidence suggests previously undocumented benefits to co-location between old and young firms.

Optimal investment with vintage capital: Equilibrium distributions

The paper concerns the study of equilibrium points, or steady states, of economic systems arising in modeling optimal investment with vintage capital, namely, systems where all key variables (capitals, investments, prices) are indexed not only by time but also by age. Capital accumulation is hence described as a partial differential equation (briefly, PDE), and equilibrium points are in fact equilibrium distributions in the variable of ages. A general method is developed to compute and study equilibrium points of a wide range of infinite dimensional, infinite horizon, optimal control problems. We apply the method to optimal investment with vintage capital, for a variety of data, deriving existence and uniqueness of equilibrium distribution, as well as analytic formulas for optimal controls and trajectories in the long run. The examples suggest that the same method can be applied to other economic problems displaying heterogeneity. This shows how effective the theoretical machinery of optimal control in infinite dimension is in computing explicitly equilibrium distributions. To this extent, the results of this work constitute a first crucial step towards a thorough understanding of the behavior of optimal paths in the long run.

Modelling energy transition risk: The impact of declining energy return on investment (EROI)

A number of papers in the field of net energy analysis have argued that declines in energy return on investment (EROI) could lead to increasing energy prices and a fall in economic growth. This paper develops a model (TranSim) which can simulate the economic and financial implications of an energy technology transition involving a reduction in EROI, by combining the stock-flow consistent (SFC) approach with an input-output (IO) model.The TranSim model has the following key features. First, it includes three firm sectors, that produce energy, capital, and other (non-energy, non-capital) goods. Second, an IO model and an Almost Ideal Demand System are integrated into the SFC model. Third, capital vintages have embedded levels of labour productivity and intermediate good requirements that depend on the economic conditions in the period the vintage was produced.Simulations are characterised by an initial increase in output (due to higher investment), followed by periods of recession and below trend growth (due to price inflation and changes to the functional income distribution). The negative effects associated with the transition – recession, stagnation, stagflation, increasing inequality and asset stranding – are positively related to the capital intensity of green energy production and reductions in EROI.

Embodied and disembodied technological change: The sectoral patterns of job-creation and job-destruction

This paper addresses, both theoretically and empirically, the sectoral patterns of job creation and job destruction in order to distinguish the alternative effects of embodied vs disembodied technological change operating into a two-sector economy. Disembodied technological change turns out to positively affect employment dynamics in the “upstream” sectors, while expansionary investment does so in the “downstream” industries. However, these labour-friendly impacts are barely significant from a statistical point of view. Conversely, the replacement of obsolete capital vintages tends to exert a negative impact on labour demand and this effect turns out to be highly significant.

Young Firms, Old Capital

Across a broad range of equipment types and industries, we document a pattern of local capital reallocation from older firms to younger firms. Start-ups purchase a disproportionate share of old physical capital previously owned by more mature firms. The evidence is consistent with financial constraints driving differential demand for vintage capital. The local supply of used capital influences start-up entry, job creation, investment choices, and growth, particularly when capital is immobile. Conversely, incumbents accelerate capital replacement in the presence of more young firms. The evidence suggests previously undocumented benefits to co-location between old and young firms.

Economic Retirement Age and Lifelong Learning: A Theoretical Model With Heterogeneous Labor, Biased Technical Change and International Sourcing

AbstractThe employability of an aging population in a world of continuous and biased technical change is top of the political agenda. Due to endogenous human capital depreciation the effective retirement age is often below statutory retirement age resulting in permanent non-employability of older workers. We analyze this phenomenon in a putty-putty human capital vintage model and focus on education and the speed of human capital depreciation. Introducing a two-stage education system with initial schooling and lifelong learning, not even lifelong learning turns out to be capable of aligning economic and statutory retirement. However, well-designed education programs will keep more workers in highly productive activities at the end of their working life, and hence will substitute for simple social transfers, or for an early switch towards very low paid jobs.

Investment, technological progress and energy efficiency

Abstract In this paper we propose a theory to study how the aggregate demand of energy responds to energy prices and technical innovations that affect the price of energy services. In our theory, energy use is determined by the interaction of the choice of Energy Saving Technical Change with energy prices and Investment Specific Technical Change (ISTC). The key mechanism is that the energy saving technology is embodied in capital vintages as a requirement that determines their energy intensity. We show that higher ISTC that increases the quality of capital goods is an energy saving device and, therefore, a substitute for Energy Saving Technical Change (ESTC). However, higher ISTC that rises the efficiency in producing capital goods is energy consuming and fosters ESTC to compensate for the amount of energy required by the new investment. A higher price of energy also induces a higher level of ESTC, but the aggregate amount of energy used may not be affected as investment does not change. These effects are amplified with rising prices of energy. Thus, our theory can be used to test when and how we should see a rebound effect in energy use at the aggregate level and to evaluate the aggregate effect of any policy aiming to reduce energy use.

Optimal Investment with Vintage Capital: Equilibrium Distributions

The paper concerns the study of equilibrium points, or steady states, of economic systems arising in modelling optimal investment with vintage capital, namely, systems where all key variables (capitals, investments, prices) are indexed not only by time τ but also by age s. Capital accumulation is hence described as a partial differential equation (briefly, PDE), and equilibrium points are in fact equilibrium distributions in the variable s of ages. Investments in frontier as well as non-frontier vintages are possible. Firstly a general method is developed to compute and study equilibrium points of a wide range of infinite dimensional, infinite horizon boundary control problems for linear PDEs with convex criterion, possibly applying to a wide variety of economic problems. Sufficient and necessary conditions for existence of equilibrium points are derived in this general context. In particular, for optimal investment with vintage capital, existence and uniqueness of a long run equilibrium distribution is proved for general concave revenues and convex investment costs, and analytic formulas are obtained for optimal controls and trajectories in the long run, definitely showing how effective the theoretical machinery of optimal control in infinite dimension is in computing explicitly equilibrium distributions, and suggesting that the same method can be applied in examples yielding the same abstract structure. To this extent, the results of this work constitutes a first crucial step towards a thorough understanding of the behaviour of optimal controls and trajectories in the long run.

Embodied and Disembodied Technological Change: The Sectoral Patterns of Job-Creation and Job-Destruction

This paper addresses, both theoretically and empirically, the sectoral patterns of job creation and job destruction in order to distinguish the alternative effects of embodied vs disembodied technological change operating into a vertically connected economy. Disembodied technological change turns out to positively affect employment dynamics in the upstream sectors, while expansionary investment does so in the downstream industries. Conversely, the replacement of obsolete capital vintages tends to exert a negative impact on labour demand, although this effect turns out to be statistically less robust.

Vintage Effects In Human Capital: Europe Versus The United States

The standard assumption in growth accounting is that an hour worked by a worker of given type delivers a constant quantity of labor services over time. This assumption may be violated due to vintage effects, which were shown to be important in the United States since the early 1980s, leading to an underestimation of the growth of labor input (Bowlus anA1d Robinson, 2012). We apply their method for identifying vintage effects to a comparison between the United States and six European countries. We find that vintage effects led to increases of labor services per hour worked by high‐skilled workers in the United States and United Kingdom and decreases in Continental European countries between 1995 and 2005. Rather than a productivity growth advantage of the US and UK, the primary difference with Continental European countries was human capital vintage effects instead.

Cohesion policy and inequality dynamics: Insights from a heterogeneous agents macroeconomic model

Regions within the European Union differ substantially not only with respect to per capita GDP, but also with respect to income inequality within the regions. This paper studies the effects of different types of technology-oriented cohesion policies, aiming at the reduction of regional differences, on the convergence of regions and the dynamics of income inequality within regions. In particular, policies are analyzed using a two-region agent-based macroeconomic model – the Eurace@Unibi model – where firms in the lagging region receive subsidies for investment in physical capital. It is demonstrated that the short-, medium- and long-term effects of the policies on per-capita output and between- as well as within-regional inequality differ substantially. Effects depend on how successful the policy is in incentivizing firms to choose best available capital vintages and on how flexible labor markets are in the targeted region.

Production-Based Term Structure of Equity Returns

We propose a unified general equilibrium production-based model to study the negative link between timing of cash flows and expected returns both in the cross section of stocks and along the aggregate equity term structure. Our economy incorporates long-run growth news and heterogenous exposure to aggregate productivity shocks across capital vintages, yielding a downward-sloping term structure, consistent with the empirical findings of Binsbergen et al. (2012). This result is preserved after the introduction of an endogenous stock of growth options that enables us to reproduce the empirical negative relationship between cash-flow duration and expected returns in the cross section of book-to-market-sorted stocks.

Economy-wide effects of international and Russia's climate policies

The objectives of this paper are to analyse the economy-wide effects of international climate policy on the Russian economy as well as the effects of Russia's climate policy on European economies. Our analysis is based on a general equilibrium model that includes inertias, such as imperfect sectoral labour mobility and vintage capital, and has a detailed depiction of the power generation sector. We found that international climate policy could reduce Russia's private welfare by 1.8% annually due to lower revenues from exports of fossil fuels. At the sectoral level, Russia could gain a comparative advantage in producing energy-intensive commodities and hence Russia's producers of those commodities increase their production and export supplies. This could result in a carbon leakage in Russia. Eliminating implicit subsidies on domestic consumption of gas and petroleum products could reduce Russia's private welfare loss by 0.6% points and eliminate the carbon leakage. Nevertheless, eliminating implicit subsidies on gas and petroleum products might not be sufficient to achieve the pledged emission reductions by 2030. Moreover, this leads to an undesirable increase in coal consumption and therefore, some additional climate policy such as a carbon tax or an emission trading system might be required. We also found that Russia's climate policy could have positive but moderate effects on the European economies; in particular, countries such as Lithuania, Slovakia, and Hungary benefit due to decreased export prices for gas, crude oil, and petroleum products from Russia.

Investment, Tobin's Q, and Vintage Capital: Theory and Evidence

This paper extends the Q-theory of investment to capital goods with arbitrary efficiency profiles. When efficiency is non-geometric, the firm's capital stock and the replacement cost of its assets are fundamentally different aggregates of the firm's investment history. If capital goods have constant efficiency over a finite useful life, then simple proxies are readily available for both the replacement cost of assets in place and capital stock. Under this assumption, we decompose the total investment rate along two dimensions: into its net and replacement components, and into its cash and non-cash components. We then show that these components exhibit significantly different economic determinants and behavior.

Economic Retirement Age and Lifelong Learning - A Theoretical Model with Heterogeneous Labor, Biased Technical Change and International Sourcing

The employability of an aging population in a world of continuous and biased technical change is top of the political agenda. Due to endogenous human capital depreciation the effective retirement age is often below statutory retirement age resulting in permanent non-employability of older workers. We analyze this phenomenon in a putty-putty human capital vintage model and focus on education and the speed of human capital depreciation. Introducing a two-stage education system with initial schooling and lifelong learning, not even lifelong learning turns out to be capable of aligning economic and statutory retirement. However, well designed education programs will keep more workers in highly productive activities at the end of their working life, and hence will substitute for simple social transfers, or for an early switch towards very low paid jobs.

The complex interactions between economic growth and market concentration in a model of structural change

We study the relation between variety, market concentration, and economic growth, along different phases of economic development which entail a number of changes to the structure of production and consumption in the economy. We focus on three aspects of structural change, which are connected and are correlated to variety, market concentration, and economic growth: (i) product quality; (ii) firms’ mark-ups; and (iii) imitation of consumer preferences for price and quality. We model the interactions among several aspects of structural change such as firm size and hierarchical structure, innovation in capital vintages, the emergence of social classes, income distribution, and consumer preferences across and within classes. We find that market concentration has a significant and positive impact on economic growth only in the presence of sufficiently large demand. The strongest effects emerge in the presence of a more skewed firm size distribution and firms producing higher priced and higher quality goods. We find also that this effect is influenced strongly by different aspects of structural change. Changes in the behaviour (or income) of the less wealthy income classes is crucial as is investment in new capital vintages, and the emergence of diverse income classes with heterogeneous consumption preferences. In contrast, we find that supply side product variety, cœteris paribus, has no significant effect on growth.