Asymmetric substitutability between energy and capital: Evidence from the manufacturing sectors in 10 OECD countries

This paper investigates the substitutability between energy and capital in the manufacturing sectors of ten OECD countries since 1980 by applying a cost function approach that has been widely used to analyze industrial energy demand. First, we attempt to determine the source of the disagreement in the literature on the substitutability between energy and capital and reach a conclusion regarding the substitutability between energy and capital. Dividing energy and capital into sub-inputs, we analyze their substitutability. The empirical results indicate that fuel tends to complement capital in most countries, whereas electricity and capital are substitutes. Thus, this study confirms that heterogeneity in energy sources is a primary component of the systematic variation in the substitutability between energy and capital. Second, we examine asymmetric substitutability between energy and capital by estimating the Morishima elasticity of substitution. The estimates of the Morishima elasticity of substitution demonstrate that the substitution of energy for capital has dominated the substitution of capital for energy. This asymmetric substitutability is natural from the producer perspective because capital costs are much greater than energy costs in most countries. These results imply that the adoption of energy-saving technologies has not been induced in response to increased energy prices.