Obsolescence of Fixed Capital

Obsolescence of Fixed Capital


the decrease in value of fixed capital that results from rising labor productivity and technical progress.

Such obsolescence occurs in two forms. The first relates to a decline in the value of fixed capital that takes place when objects of the same design are produced with a lesser outlay of labor and thus become cheaper; this is the result of rising labor productivity over time in the sectors producing the objects. Mass production of these items leads to a sharp decrease in their value and in their prices. As a result, the value of older objects having the same technical characteristics as newer ones is determined by the new cost and the resulting price. This first form of obsolescence is most typical of machines and structures that do not undergo major changes in basic design for long periods of time.

The second form of obsolescence is linked to the appearance in society of new, more productive, and more economical technology through scientific and technological progress. Through such factors as automated control, greater operating reliability at reduced cost, and improved labor safety techniques, such technology is more efficient. This leads to a situation in which existing machinery that is not physically worn out becomes obsolete. The value of old machinery and equipment drops in proportion to the relative decrease in its efficiency. This second form of obsolescence operates with greatest force during the initial period of introduction of new machines, devices, and instruments. It is especially typical of machine technology but also applies in some degree to buildings, in particular to new shop facilities that are more suitable for production and work than the old ones. The obsolescence of certain fixed capital may also relate to obsolescence of the product it turns out. The same fixed capital may be subject to both forms of obsolescence simultaneously.

Obsolescence leads to the appearance of specialized types of fixed capital pricing. Among these are full replacement cost, that is, the difference between the complete initial cost of the objects and the losses owing to obsolescence, and net replacement cost, that is, the difference between complete replacement cost and the amount of physical wear.

For the most part, obsolescence of fixed capital occurs independently of conditions within the enterprise employing such capital; it is largely brought about through the reduction of production costs where the physical components of this fixed capital are made. The process of obsolescence is continuous, but calculations of replacement cost are carried out only periodically because they require large expenditures. A number of reappraisals of fixed capital related to the conditions of capital reproduction have been carried out in the USSR.

Technological progress makes up for losses from obsolescence. The losses on initial value sustained by fixed capital owing to the appearance of more economical technology or to the obsolescence of the products being turned out are compensated through economic advantages gained during the initial period of application of a given technology, when it is advanced and thus assures higher than ordinary profits. Such compensation for losses from obsolescence is a necessary condition for effective management of the economy. Therefore only the most highly developed technology should be introduced into production. It is also important that fixed capital be used with sufficient intensity per unit of time during its entire economic life. Low productivity of fixed capital and an inadequate equipment shift index diminish these intended effects and lead to uncompensated losses due to obsolescence.

The second form of obsolescence involves a decrease in the economic life of fixed capital. The consequences of such obsolescence are partially eliminated by equipment modernization. But sometimes even modernization cannot overcome the economic disadvantage inherent in further operation of existing fixed capital. This type of obsolescence is unavoidable. The necessary reduction in the economic life of fixed capital that is caused by the second form of obsolescence must be taken into account when calculating depreciation norms. Existing depreciation norms related to the purchase of new equipment for the most part take account of the reduced economic life of fixed capital due to obsolescence; depreciation norms applying to capital repair include a portion of the expenditures set aside for modernization. Any increase in the efficiency of social production requires constant refinement of depreciation norms and their strengthened influence on the acceleration of technical progress.

Unlike the obsolescence of fixed capital in the capitalist countries, allowable obsolescence of fixed assets under socialism is determined from the point of view of the entire society, not from the standpoint of the private entrepreneur. The reproduction of those objects that comprise socialist public property is centrally planned.


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