ON SUBSTITUTION POSSIBILITIES BETWEEN ENERGY AND NON-ENERGY INPUTS

A NESTED CES PRODUCTION FUNCTION ANALYSIS

Abstract

The purpose of this paper is to investigate the substitution possibility between energy and non-energy inputs. An emphasis is placed on the energy-capital relationship because at present there is a controversy on whether energy and capital are substitutes or complements.
In this paper we estimate the Allen partial elasticities of substitution (AES) among capital, labor, materials and energy. The functional form employed here is the nested CES function. We estimate it under an assumption that energy and capital are separable from others. This assumption enables us to decompose the AES between energy and capital into two effects. One is the substitution effect within energy-capital aggregates and the other is the substitution effect of labor and materials against energy-capital aggregates.
The units for estimation are manufacturing industries in Japan. The data used are obtained by pooling cross-section data of more disaggregated sectors at five years (1965, 1970, 1975, 1977 and 1978).
Based on our results, it is found that labor and materials are substitutable for energy. We also find that the AES between energy and capital estimated from the samples after the oil crisis in 1973 are positive, indicating energy-capital substitutability while those from the whole samples are negative or essentially zero, indicating complementarity or independence of energy and capital. The decomposition analysis of the AES shows that energy-capital substitutability after the oil crisis in 1973 was a consequence of the strong substitution effect within energy-capital aggregates. This may be reflected the rising tendencies of energy-saving type of investment.