Obsolescence

Working Paper: CEPR ID: DP2833

Authors: Thorvaldur Gylfason; Gylfi Zoega

Abstract: Does it always pay to install high-quality capital? Or could it possibly be more profitable to make investments that do not last too long? In this Paper we ponder the optimal rate of depreciation of physical capital, first in the Solow model and then in a model of endogenous growth with learning-by-doing. Optimal durability and depreciation, including obsolescence, are attained when the marginal benefit of increasing durability ? and thus reducing the need for future replacement investment ? is equal to the marginal cost, which is the additional cost of investing due to the higher quality of capital. The optimality conditions are set out as golden rules for the quality, or durability, of capital. They entail that the higher the rate of population growth or technological progress, the larger the marginal cost of investing in durability and the lower the optimal level of durability; hence, the higher the optimal rate of depreciation. We then use a customer-market model to derive the privately optimal level of durability, and find that there is nothing in the model that ensures the socially optimal level of durability and depreciation.

Keywords: capital; depreciation; economic growth; obsolescence

JEL Codes: E23

Causal Claims

Cause	Effect
increased population growth (J11)	accelerates depreciation (G31)
accelerates depreciation (G31)	slows down economic growth (F62)
increased technological progress (O39)	accelerates depreciation (G31)
accelerates depreciation (G31)	diminishes output per capita growth (O49)
higher saving rates (D14)	accelerate depreciation (G31)
accelerate depreciation (G31)	reinforces positive effects of saving on economic growth (E21)
increased efficiency (D61)	higher depreciation rates (G32)
higher depreciation rates (G32)	strengthen positive effects on economic growth (O29)