Solow on Hotelling

When Harold Hotelling died on December 26th 1973, Robert Solow gave the Robert T. Ely Lecture as a tribute to him. "The Economics of Resources or the Resources of Economics" is a fascinating time document of resource economics concern. The 1973 Oil Crisis, which resulted from OAPEC's embargo had resulted in quadrupling of the oil prices, disrupting of the world energy market and collapse of the Bretton Woods system. It is extremely interesting to look into how contemporary economists reflected on the issues of the day. Yet it is not the the external shocks and the Middle Eastern politics that Solow's lecture is about - it is more about understanding "the long-run pursuit of a general policy towards exhaustible resources."

Much of the lecture's content would be familiar to resource economics students. The fundamental theory of Hotelling has been rediscovered and built upon for decades and remains still essential today. Solow reminded that despite the possibility of recycling many resources still remain exhaustible. "The laws of thermodynamics and life guarantee that we will never recover a whole pound of secondary copper from a pound of primary copper in use, or a whole pound of tertiary copper from a pound of secondary copper in use."... 

Backstop technology

The fundamental principle and the coordination of flows and stocks though the perfect operation of forward markets would guarantee that the price would rise and production would fall along the demand curve until the resource has "priced itself" out of the market. It is fascinating to see what the trend for backstop technology was. Direct sunlight for energy production didn't exist yet (though Solow expected it would some day). It was U 238, which was the backstop perspective at the time. Interestingly enough uranium reserves were thought to endure as an energy resource for millions of years in 1974 at the consumption rates of the time, whereas today they were estimated to last only for 85-200 years at the current consumption rates. 

The great expectations

"The transvaluation of values" (Nietzsche applied in resource economics) argument examines expectations and the fact that anticipations about price developments have a reinforcing effect - when resource owners expect the price to be rising too slowly, they would try to withdraw from the market faster, which would put a further pressure on the price through the increased production and vice versa. The resulting phenomena would be dumping or speculative withholding... Since the optimal path is achieved though amendments in the price, the more consistent and true expectations are, the better. This is why a perfect sequence of forward market is the precondition for the Hotelling optimality. It is however an illusion that resource markets would be so tranquil - they are more than often vulnerable to external shocks.

To discount or Not to discount and... how to discount?

The perennial question of how to discount and the market rate being higher than the social discount rate (ultimately resulting in faster rise in prices and decline in production) does not elude the lecture. The general conclusion is that "even well-functioning competitive markets may fail to allocate resources properly over time. ... The choice of a social discount rate is, in effect a policy decision about intergenerational distribution."

How serious?

There are two factors, which determine the seriousness of the resource-exhaustion problem:

• the likelihood of natural-resource saving technological progress, and
• the ease of production factor substitutability.

Even if we know that the natural resource input per unit of real output has declined over time, it is still an important and interesting assignment to make out what the implications of the zero-technological-progress case would be. And then the second argument - there would be of course no problem with exhausting resources as long as there would be renewables, which would substitute them in production - otherwise we're in trouble.

Public policy

For all the imperfections that exist, Solow suggests that some central planning would be beneficial - regarded that would entail the implementation of specific policies and not unconditional centralization. For the discrepant discount rates public intervention can try to slow down the rate of resource exploitation through conservation subsidies or a system of graduated severance taxes. The government could play a role in gathering and dissimilating information about trends in technologies, reserves and demand - this would create consistent expectations about the far future and prevent major error paths (extracting the resource too late or too soon).