Dr. Adeliada Mehmetaj
Lecturer of Economics Albers School of Business and Economics Seattle University
Based on her working paper "Technological Progress and Capital Obsolescence: Implications for Productivity Growth"
Capital and Labor are the two most important factors of production and as such anything that affects either will have important implications for economic growth. Technology is embedded in capital and improvements in technological innovation make physical capital more productive over time. A consequence of new capital becoming more productive, is the faster rate of depreciation of older capital, as an optimal decision taken by firms themselves. Examples of this natural process of making older, less productive capital obsolete in the face of new and improved technologies, vary from something as simple as smart phones replacing flip phones to computers, buildings, machinery ect. The faster the innovation is, the more older capital will become obsolete. What does this mean for macroeconomies and their economic growth? A general misconception is that technological innovation will without a doubt increase overall growth. That is not necessarily true. If older capital is completely retired instead of repurposed, the impact of innovation on aggregate capital is unclear. Innovation results into higher quality/more productive new capital units, which in turn affect aggregate capital stock positively. Alternatively, it also increases depreciation through the retirement of older capital and this has a negative impact on capital stock available to produce as a result. If the depreciation channel dominates, overall capital stock goes down and GDP growth will also go down as a result. Otherwise, if depreciation is lower that the improvement in the quality of capital due to higher innovation, then GDP growth will be higher. What does this mean in practice? For the misconception that technological innovation increases economic growth to be true, the increase in the rate of obsolescence(economic depreciation) must be lower than the increase in the quality of new capital units. What can be done to achieve this? Instead of letting say an old shopping mall to become obsolete in the face of a new, more innovative shopping mall being opened right next door, the old building can be restructured/repurposed to fit the new economy better.