Oil crisis, Energy Saving Technological Change, and the Stock Market Collapse of 1974

The market value of U.S. corporations, relative to the replacement cost of their tangible assets, declined by about 50% in 1973-74, and stagnated at that level for the following decade. This collapse in market valuations exactly coincides with the Oil Crisis of October 1973. Over the 1973-78 period, the OPEC embargo translated into 44% increase in energy prices. This paper uses a calibrated dynamic general equilibrium model to quantitatively assess the impact of the energy price increase on the market valuation of U.S. corporations. The key features of the model are the technology-specific nature of capital, the irreversibility of investment decisions, and the induced innovation hypothesis. In the model, the arrival of a new energy-saving technology coincides with the increase in energy prices; rendering old capital obsolete, and its market value to collapse. In the data, the number of patents granted to enery-saving technologies increased in the mid 1970's, which gives empirical support to the induced innovation hypothesis. We find the observed changes in energy prices, together with the energy saving change implied in the observed energy output data, generate an 17% drop in Tobin's q; slightly more than a third of what is observed in the data.