scarcity_tech_change,brown

scarcity_tech_change,brown - llatoral Resource Scarcitq and...

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Unformatted text preview: llatoral Resource Scarcitq and lechnoloeical (hanee Stephen P. A. Brown and Daniel Walk '17 [leis article, we examine trends in [be real price; of nonrenewable natural resources to determine whether technological claange is outpacing geophysical scarrin of [Irate natural resources. Stephen R A. Brown is director of energy economics and microecanomlc polio! analysis in (fee Research Department a! tire Federal Reserve Bank afDallar. Daniel Well is a researrli‘anaijrst in tire Research Department at the Federal Reserve Ban/c of Dallas. In 1972, an interdisciplinary research group called the Club of Rome predicted worldwide ' catastrophe by 2050 (Meadows et‘ a]. 1972). They based their prediction on three trends they thought they observed: increasing scarcity of nonrenewable natural resources, increasing environmental degradation, and continuing population growth. They saw the combination 'of these trends as unsustainable and economic misery as inevitable. The Club of Rome was not original in its pessimism about the future. English economist Thomas R. Malthus raised similar concerns in 1798. His analysis led him to conclude that mis- ery was the inevitable state of humans (Malthus 1798). According to Malthus, if per capita income were above subsistence. population would expand until per capita income was reduced to subsistence level. (See me box enti— tled "An Overview of Malthus' Principle of Population“) At the time Malthus was writing— the early stages of the Industrial Revolution— poverty was widespread in English cities, so perhaps his pessimism was understandable. Fortunately for us, Malthus was ‘wrong. Since at least the late 18005. per capita income in Western society has generally increased. Technological change occurred at a rapid pace, causing per capita income to rise even as the population grew. In fact, per capita income rose so much. the Club of Rome's pessimism seems hard to understand. except that Malthus' origi- nal analysis did not take into account natural resource scarcity or environmental degradation. This essay examines whether the potential scarcity of nonrenewable natural resources is a reason for concern. Previous research (Barnett and Morse ‘1963. Jorgenson and Griliches 1967. Nordhaus 1973, Brown and Field 1978, Fisher 1979. Hartwick and Olewiler 1986, and Schmidt 1988) is mixed. but it generally has found that the economic evidence is inconsistent with the increasing scarcity of nonrenewable natural resources. In fact. technological change driven by free market forces has increased natural re- source availability. Given the time elapsed since the previous research was conducted. however. it is appropriate to reexamine the evidence. WHAT IS NATURAL RESOURCE SCARCITY? Nonrenewable natural resources. such as aluminum and crude oil, exist in fixed amounts on Earth. When we use up all the crude oil on the planet, we will have no more of this resource. In addition, we tend to use the most easily obtainable natural resources first. Over FEDERAL RESERVE BANK OF DALLAS time. natural resources become more difficult to extract. For example, at the beginning of the California gold rush. people were picking up gold ofi‘ the ground. Toward the end of the gold rush. they were blasting the mountains with water. using much more capital and labor. Geophysical scarcity may be irrelevant, however. if technological change increases resource availability. Consequently, economists prefer to measure scarcity in economic terms— that is. through market prices. Economists are interested in whether the prices of nonre- newable natural resources reflect increasing scarcity. In other words. are the real prices of natural resources rising to reflect increasing scarcity? The economics perspective can be illus- trated by examining a production function for the overall economy: (1) Q = QlK. L. NR). where Q is output. K is capital, 15 is labor. and NR is natural resource use.‘ We expect normal economic canditions for production. which mean a positive marginal product for each input: (2) £>U a—Q>0 BO . . ———— > 0. 8K at Bill]? For each input, output increases with its use. as is shown by the positive first derivative. Normal economic conditions for produc- tion also mean a diminishing marginal product for each input: 2 n) 19<n 3K2 31.2 For each input. output increases at a deereasing rate with increased use of the input. as is shown by the negative second derivative. Economic theory also suggests how the increased provision of capital. labor, and natural resources affects the productivity of each other input. For instance. the productivity of capital and labor is expected to increase as natural resource use increases: so no 4 c U now) can In words. the marginal product of capital and the marginal product of labor increase when more of the natural resource is used. ‘ Similarly. the productivity of the natural resources increases if either capital or labor increases: >0 2 ' z a Q > 0, a 0 > 0. BNRBK ElNRElL t5) ECONOMIC AND F INANCIAL REVIEW FIRST QUARTER 2000 An Overview of Malthus' Principle of Population ~ Mallhus thought an increase in population would reduce per capita income. His conclusion followed from the law of diminishing marginal productivity: asspopulation _ increases. each worker has less land with which to work. Curve I in the figure repre- - ' sents this proposition for a given amount of land and level of technology. Curve ll represents this proposition for a higher level of technology andlor greater acreage, The subsistence level of income is also represented In the figure; ' . ‘ “'- _ For a given amount of land and level of technology. Malthus argued that-spoo- ulation would tend toward a subsistnce level of income. If per capita income were ' below the subsistence level (as illustrated by point A on curve I)l starvation would reduce the population. If per capita income were above the subsistence level (as illustrated by point B on cums I). people would have more children and population would grow. In either case. population would adjust until income just reached the subsistence level (at point C on curve I). Therefore. he concluded that misery was the Inevitable state of humankind. This conclusion ls often referred to as the "dismal theorem" and may be the historical basis for calling economics "the dismal science.’ Maithus' analysis is similar to that now made by ecologists studying animal pop- ulations and ecosystems. For example. if the deer population is smaller than a given ecosystem can support. the deer will reproduce and multiply in number. If the popu- lation Is raster than the ecosystem can support. the weak will disI off and the popu— lation will be reduced. The deer population tends toward a subsistence level of nutri- tion. Malthus further argued that—without moral restraint in human reproductlon- improved technology or increased resources would only increase human misery in the long run. An increase tn technology or land temporarily increases well-being (as l shown by a shift from point C on curve I to point D on curve II). Eventually. however, 'the Increased capacity of the economy wiil lead to population growth. which will only be checked when per capita income reaches subsistence (point E on curve ll). ' Hence,'Maithus concluded that increased technology or tend availability would result in more people living at subsistence. not an Improvement in living conditions. This conclusion is often referred to as the "utteriy dismal theorem." Per caplla lnoorm In words. the marginal product of natural resources is greater when either more capital or more labor is used. If we take increasing natural resource scarcity to mean natural resource availability de— creases over time, then as capital and labor grow the production conditions described above can explain the economic manifestation of natural resource scarcity and why it might be expected to limit economic growth. The conditions expressed in inequalities 4 and 5 show that if natural resource use declines while capital and labor grow. the marginal productivity of natural resources will rise and the marginal productivity of capital and labor will fall. Hence. increasing natural resource scarcity would imply that nat- Population ural resource prices rise relative to wages and the return to capital. The economic conditions described above also suggest that in a world without technolog- ical change. output cannot keep pace with pop— ulation growth unless natural resource use and capital grow at the same rate. In fact. if natural resource use grows more slowly than capital and labor-was greater natural resource scarcity would imply—output must grow more slowly than capital and labor unless there is techno- logical change. ANOTHER PERSPECTIVE ON NATURAL RESOURCE SOARCITV Hotelling (1931) develops a model to explain how the prices of nonrenewable natural resources—such as oil. natural gas. coal. cop- per. nickel. bauxite. zinc. and iron—would evolve over time in the absence of technologi— cal change. Hotelling's analysis exploits the proposition that the quantity of nonrenewable resources is fixed. The consumption of the resource today reduces the amount available for future consumption. and the owner of such a resource must decide how to distribute its use over time. In an economy in which other investments earn a market rate of interest. individuals saving nonrenewable natural resources for future peri- ods also must expect to earn the market interest rate (including the appropriate risk premium). if the expected return to saving a nonrenewable natural resource for future periods is less than the market interest rate. managers of that resource will save less of it for the future. This will make the resource more plentiful today and less plentiful in the future, which will lower today's price. raise future prices, and increase the expected return to saving the resource for future periods. On the flip side, if the expected return. is greater than the market interest rate, man- agers will save more of the resource for future periods, making it less plentiful today and more plentiful in the future. This will raise today's price, lower future prices. and decrease the expected return to saving the resource for the future. Only when the expected return is equal to the market interest rate will managers of the resource consider their production plans finalized. Under these conditions. the difference between the price and marginal cost of producing a nonrenewable natural resource will rise at the market interest rate unless production costs are affected by re- source depletion (Solow 1974): (5) Para: = Cm: + jLe"- where Pm, and Cm, are the price and marginal cost of producing the natural resource at time t, respectively. I is the market interest rate. and he" is the value of holding an additional unit of the resource off the market until a future period (a practice economists call “user cost"). The relationship described by Equation 6 is com- monly called the "l-[oteliing rule." With CX‘, representing the effects of cumu- lative production on the cost of producing the natural resource at time t. Peterson and Fisher (1977) show (7) it = —e'"Cx,, which means it is constant over time and the user cost grows at the interest rate unless pro- duction costs change with cumulative extraction (Cx, at 0). If production costs rise with cumula- tive extraction (CA1, > O). the user cost rises more slowly than the interest rate.2 The price of the natural resource is expected to rise over time. however. whether or not production costs rise with cumulative extraction (CyJ 2 0).3 Financial markets and forecasts of future prices are generally consistent with theory reflecting expectations that prices for nonre- newable natural resources will rise over long periods of time.‘ In fact, the Hotelling rule is best interpreted as a market efficiency condition describing how current and expected future prices for these resources are simultaneously determined by current market conditions and expectations about future market conditions. For nonrenewable natural resources. current prices and expectations about future prices depend on the information and technology available at the time. MARKET-INDUCED TECHNOLOGICAL CHANGE As demonstrated above. if a nonrenewable natural resource is expected to become more scarce in an economic sense. its price will be expected to rise. In a market system. expecta— tions of higher prices increase the incentive to find new technologl that will offset geophysical scarcity. When they expect higher prices. con- sumers have an incentive to look for new tech- nology that lets them use less of a natural resource. When they anticipate higher produc— tion costs. producers have an incentive to de- velop new technology to lower costs. In short, the very mechanism that signals increasing eco- nomic scarcity of a nonrenewable resource helps FEDERAL RESERVE BANK OF DALLAS _ Tablet 7 Natural Resource Prices Deflated by the Consumer Price index Commodity 1870 1000 1090 1900 Aluminum * ‘ ’ 55.71 Anilvarite coal 100.00 67.95 91.90 103.42 Bituminous coal 100.00 61.90 69.67 70.04 Copper 100.00 132.27 103.56 116.08 Iron 100.00 112.49 79.15 91.99 Lead 100.00 105.67 102.15 107.87 Natural gas ‘ ' * ‘ Nickel 100.00 97.25 71.47 59.36 Oil 100.00 31.91 28.08 45.86 . Silver 100.00 113.30 111.11 70.06 Sisal “ ‘ * 162.63 Tin ‘ 100.00 110.51 166.75 Zinc 100.00 102.06 110.56 95.54 1910 1920 1930 1940 1950 1960 1970 33.92 23.21 20.27 16.96 10.46 12.48 10.51 117.74 140.26 . 177.33 164.64 214.19 152.96 161.56 76.00 116.75 64.60 66.40 126.07 100.69 102.92 62.45 52.28 47.43 49.21 53. 65 65.35 69.50 71.52 93.41 47.98 71.10 _ 85.47 96.13 ' 63.42 96.31 61.72 67.42 75.60 113.06 62.23 82.74 ' 97.76 94.86 66.67 56.26 96.50 91.76 42.41 20.76 20.76 24.74 16.53 24.77 32.93 21.45 50.37 23.43 23.91 34.27 31.96 26.92 55.10 46.57 21.71 23.81 29.32 29.31 43.46 126.97 125.64 67.37 129.27 121.53 161.71 151.56 169.60 1 12.24 66.39 165.32 164.67 159. 39 206.72 104.69 70.57 49.94 61.43 104.66 79.56 71.42 1930 ' 13.12 296.63 224.36 73.52 1 13.36 105.45 401.75 35.58 86.05 236.64 165.62 477.54 82.20 ' All oommoclilles indexed to 1870 = 100 except lumlnum (1895 = 100). natural gas (1919 = 100). steel (1097 = 100). and tin (1860 w 100). SOURCE: Authors‘ calculations using data from Bureau of Labor Statistics. Department of the Interior. Departmental Energy. and Manthy (1978). stimulate the technological change that will off- set that scarcity.s Whether technology advances rapidly enough to prevent a rise in the prices of the resources. however. is a question best left to the evidence. WHAT IS THE EVIDENCE? The conditions described above form a basis to test whether nonrenewable natural resources are becoming more scarce in an eco- nomic sense or whether technological advance is making them more plentiful. Rising real prices for nonrenewable natural resources would pro- vide evidence that technological advance has not offset increased geophysical scarcity; con- stant real prices would indicate that technologi— cal advance has just offset increased scarcity: and falling real prices would signify that tech- nological advance has more than offset in— creased geophysical scarcity. In this article. we examine trends in the real prices of twelve nonrenewable natural re— sources—aluminum. anthracite coal, bituminous coal. copper, iron, lead. natural gas. nickel. crude oil. silver, tin and zinc—and one basic manufactured product. steel. to determine whether technological change is outpacing geo- physical scarcity for nonrenewable natural resources. To obtain real prices from the nomi— nal ones. we deflate the time series in two ways. The first method. suggested by the Hoteliing rule and used by Fisher (1979) and Hartwick and Olewiler (1986). uses an overall price index. such as the [1.8. Consumer Price Index (CPI). to deflate the prices of individual natural resources. This approach is the standard method for converting nominal prices to real ECONOMIC AND FINANCIAL REVIEW FIRST QUARTER 2090 prices and provides a conservative estimate of the extent to which technological progress has reduced the scarcity of nonrenewable natural resources. The second method. suggested by the pro- duction function and used by Nordhaus (1973), deflates the prices of individual natural re- sources with the average manufacturing wage. This approach shows how much human effort is required to produce a given commodity and provides an aggressive estimate of the extent to which technological progress has offset re- source scarcity. An Overview of the Price Data Under the conservative approach of deflat- ing natural resource commodity prices by the CPI. most series generally decline. as shown in Table 1.6 All but three of the commodities— anthracite coal. natural gas, and tin—had lower real prices in 1998 than they did in the first year for which data are available. In 1998. the prices of anthracite coal and tin were 22.07 percent and 9.43 percent above their respective initial values. The price of natural gas was 157.2 per— cent above its 1919 value. The prices of steel and bituminous coal were 0.44 percent and 3.68 percent below their initial values, respectively. The prices for the remaining eight commodities declined by more than 40 percent from the first year for which we have data to 1998. Most notable are nickel and aluminum prices. which in 1998 were 13.11 percent and 5.87 percent of their initial real prices. respectively. Under the more aggressive approach of deflating natural resource commodity prices by manufacturing wages. we see stronger evidence of downward trends. as shown in Table 2. By 1990 6.20 177.65 135.56 57.43 NA 73.34 277.63 31.05 51.30 35.63 134.21 140.11 105.35 1996 5.67 122.07 96.32 . ' 29.64 ‘ ' ' ‘NA' 56.36 257.20 13.11 22.52' 30.64 99.56 109.43 56.67 _ 706102 3 Natural Resource Prices 001131061 by Manufacturing Wages _- Commodity 1070 Aluminum “' Anthracite coal 100.90 ' 0110111111605 coal 100.00 ' Copper 100.00 1 iron 100.00 Lead 100.00 Natural gas ' Nickel 100.00 011 100.00 Sliver 100.00 Steel 1* Tin " 21116 100.00 1090 1000 1000 1910 1920 1930 1940 * - 3' 1_ 55.71 29.99 15.19 11.06 7.24 67.12 65.30 66.04 60.49 60.40 63.64 41.41 62.50 49.50 52.00 44.21 51.14 23.10 21.70 100.04 73.50 76.37 47.06 22.51 17.02 12.36 65.05 56.24 60.52 41.61 40.22 17.22 17.06 00.65 72.50 70.07 56.03 35.19 24.19 19.06 ' " ' ' 96.70 7025 36.61 74.22 50.76 39.06 24.67 0.95 7.46 6.21 24.35 19.95 30.03 12.46 21.69 6.41 6.01 06.47 70.95 46.62 32.05 20.92 7.79 ~ 5.90 ‘ - 162.63 114.04 62.37 47.66 40.36 100.00 162.06 143.75 129.43 63.33 41.56 54.41 70.57 70.57 62.66 60.90 30.39 17.02 ' 20.45 1900 1906 7 ' 1950 1960 1970 1900 " 3.14 2.94 2.19 .257 1.75 1.24- -1 42.33 23.70 22.14 40.05 24.92 16.98 25.31 15.63 14.10 30.09 19.00 13.39 - 10.60 10.12 ‘ 12.26 9.86 8.05 4.12 ' _ 17.09 15.20 11.43 15.20 NA NA ' 22.35 12.74 11.34 14.14 10.28 0.12 25.56 35.03 20.90 123.65 39.41 32.21 3.66 3.84 4.51 4.77 4.35 1.82 0.77 4.95 3.69 11.54 7.19 3.13 5.80 4.54 5.96 . 32.00 5.02 4.26 56.51 30.00 31.57 33.76 26.50 21.04 47.03 32.36 37.40 03.92 25.72 10.94 20.60 12.39 0.79 14.76 6.16 ' ' 11.02 ’ All commodities Indexed to 1870 '-' 100 except aluminum (1895 = 100). natural gas (1919 = 100). steel (1897 = 100). and tin (1800 = 100). SOURCE: Authors' calculations using data from Bureau of Labor Statistics. Department of the Interior. Department of Energy, and Mnthy (1978). 1998. all the commodities had lower real prices than they did in the first year for which data are available. and over half the commodities had prices that were less than one-tenth of their initial values. The 1998 prices of anthracite coal, natural gas. and tin. which show gains in the CPI—adjusted series. were 16.98 percent. 82.21 percent. and 19.94 percent of their initial values. respectively. The real 1998 prices o...
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