Discussion of Oulton and Srinivasan (O-S) on Capital and Depreciation

1. Discussion of Oulton and Srinivasan (O-S) on Capital and Depreciation Robert J. Gordon Northwestern University and CEPR ECB/CEPR/BdE Conference on Prices, Productivity, and Growth Madrid, October 17, 2003

2. The Macro Context of this Topic • Capital Stocks, Capital Services, and Depreciation • Services/Stock = Utilization • Y = F(N,UK) not = F(N,K) • A leading “explanation” (really a byproduct) of the puzzle of procyclical Solow residual and SRIRL • Work by Basu-Fernald and Eichenbaum

3. Macro Error in ignoring fluctuations in capital (capacity) utilization • Macroeconomists in the Keynesian Tradition have always treated capacity utilization as a byproduct of business cycles; utilization completely endogenous • Much of the recent macro literature, esp. the RBC and its variants, err by ignoring utilization and then can’t explain impulse-response after technology shocks • Steel in U. S.: 18% utilization rate in 1932

4. Sometimes We May Forget How Much Utilization Can Vary

5. What Did We Know about This Topic in 1967? • Perpetual Inventory Capital Stocks • Fails to Reflect Cycles of Investment • Office buildings are torn down when new buildings are constructed, same for personal computers • Exaggerates importance of physical depreciation • One-hoss shay vs. geometric depreciation • Ignores distinction between depreciation and retirement • Physical depreciation can be offset by maintenance, rarely reflected in official data • The story of this afternoon, rental shelter prices

6. Summary of Paper • Correctly endorses physical interpretation of capital stock, services, depreciation • Why we don’t want a wealth concept • asset prices – Tobin’s q, stock market bubbles • Central concept of “VICS” – volume index • Most surprising result: “no tendency for agg depreciation rate to rise over last two decades” • Why? Echoes Oliner-Sichel (1994) and Sichel (1997) that “computers are just too small to matter.” • Changing share offset by declining relative price • Yikes! What is going on with U. S. productivity?

7. The Basic Flaw in the Paper is the Failure to Define the Question • Are we talking about capital as wealth or as an input into the production function (Y = F(N,UK) • Endorses geometric depreciation • Differs from my one-hoss shay approach • My productivity in last night’s hotel room • The irony of the paper is that they reject wealth criteria but then implicitly impose a wealth criterion when endorsing geometric depreciation • The right criterion: one-hoss shay with a maintenance adjustment

8. A Misleading Message about Aggregation • “The Main Difference between the VICS and wealth-type measures of capital is the way in which different types and ages of assets are aggregated together.” • NO! • The main difference is that VICS measures are impervious to asset-price bubbles but wealth-type measures of capital are not.

9. Why Should We Care? • As Economists, because there is so much of macroeconomics that involves TFP • Simple definitional production function • y = a + bn + (1-b)k • a = y – bn – (1-b)k • a = y-n – (1-b)(k-n) • Conclusion: • Measurement errors in k create opposite signed errors in TFP

10. What the Paper Contributes • We can endorse • Physical measure of capital vs. wealth • What we cannot endorse • The theoretical section (pp. 28-39) never writes down a production function • Paper is totally unclear vs. obsolescence-type depreciation and its effect on wealth and the input of capital into the production function

11. The section on Aggregate Depreciation • Very important result that under chain-linking the aggregate real depreciation rate can rise without limit, eventually exceeding the rate on any individual asset • But “what else is new”? • We have been educated by the BEA and others since 1996 that in a world of chain-weighted deflators and real GDP, NOTHING is additive!

12. US vs UK, Geometric vs. Augmented Straight Line • Paper’s useful dichotomy • Alternative approaches to depreciation do NOT have any impact on the growth rates of the capital stock in steady state • But the chosen depreciation rate assumption obviously affects the LEVEL (or VALUE) of the stock.

13. The Heart of the Debate • P. 36 (“Sometimes it is argued that only physical wear and tear should go into the measure of depreciation used to construct capital stocks”) • This section is totally devoid of the question we want to answer by constructing such capital stock measures.

14. Other Central Conclusions • Growth rates of wealth and of VICS are insensitive to variations in depreciation rates, i.e., asset lives • The LEVEL of wealth is sensitive to depreciation rates • Why should we care? What is the question? • The input of capital into the production function answers a very different question than wealth in the consumption function

15. Estimating Depreciation in practice, pp. 41 ff • Distinction between the “pure age effect” and also the “effects of changing quality.” • Too much emphasis on computers • Diminishing returns to quality improvement in computers (my anecdotes, could have done it on a park bench) • Contrast with planes, trains, and automobiles • Here the one-hoss shay model operates with the added impact of maintenance • Why do people buy new cars?

16. The bottom line, pp. 60-61 • No big changes in depreciation/GDP over time • Echoes Oliner/Sichel (1994) and Sichel (1997) • Computers are still a small part of the capital stock • Structures are still a very large part of the capital stock • Come back at 1600H for our discussion of housing price indexes • Could you believe that housing prices is a more important topic than computer prices?