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Has Everyone Forgotten the Economics of Exhaustible Resources?
Apparently they have, judging by a new book and its blurbs
Let X be a resource with a fixed supply on earth, such as crude oil or copper. Suppose that the deposits of X amount to 100 units, and we currently use 4 units per year. When will all of X be used up?
If you answered that in 25 years X will be used up, you are not thinking like an economist. An economist would say that in a free market, prices will adjust so that you never run out of X.
But I am not writing this essay to criticize the doomsayer who fails to use economics. I am writing this essay to criticize the anti-doomsayers who wrote a new book Superabundance and the many economists whose favorable blurbs adorn the book.
In Superabundance (henceforth SA), authors Marian L. Tupy and Gale L. Pooley document that over periods of several decades, commodity prices have declined relative to wage rates. The authors interpret this to show that human ingenuity has overcome scarcity in the past and is likely to do so in the future.
This interpretation, endorsed by all of the blurbs, including those written by Nobel Laureate Angus Deaton and Obama economic adviser Jason Furman, is wrong. As I will explain below, all that we can infer from price changes in resource markets is the direction in which speculators have been surprised over the periods studied. The fact that they have been surprised in one direction in the past in no way implies that they will be surprised in the same direction in the future.
The economics of exhaustible resources was explored in a classic article by Harold Hotelling published in 1931. That article is dense and difficult, but its main lessons have been distilled elsewhere.
When the 1970s oil crisis hit, economists went back to Hotelling and updated his analysis. Among other things, they incorporated the role of commodity speculators. But since then, apparently everybody has either forgotten or never learned resource economics, and so we have the uninformed blurbs for SA.
The simple intuition of the economics of exhaustible resources is the following. Speculators try to determine what X will sell for far into the future. They take into account the available deposits, demographic changes, and consumption patterns. Suppose that a speculator owns some X and estimates that the price of X will be $100 ten years from now. The speculator estimates that it will cost $10 to store X for ten years. Then the speculator would be better off selling X today for anything over $90 and worse off selling X today for anything less than $90. Therefore, the fair price for X today is $90.
The cost of storage includes physical costs, but the primary factor is the opportunity cost represented by the interest rate. Instead of holding onto X, you can sell X today and invest in an interest-earning asset.
Calculating Real Price Changes
About ten years ago, I made a point using the price of baseball tickets for the St. Louis Cardinals. I calculated that in 1966, the most expensive ticket in the stadium cost about 4 hours of wages for what the Bureau of Labor Statistics classifies as “production and non-supervisory workers.” Forty years later, at a new stadium, the most expensive ticket cost about a month’s worth of wages. I did this calculation to illustrate that where blue-collar workers used to be able to sit next to high-status folks, this is no longer the case.
The authors of SA use a similar method to measure changes in commodity prices. That is, they compare the prices of commodities to hourly wages of low-skilled workers. On p. 114, they write,
In 1995, the average nominal U.S. price of bananas was $0.45 per pound. The average nominal compensation rate of the U.S. blue-collar worker was $16.66 per hour. The TP [time price] of a pound of bananas in 1995, then, was 0.027 hours. . .In 2018, bananas cost $.58 a pound and such workers earned $32.06 per hour, making the 2018 TP of a pound of bananas 0.018 hours
The authors want to say that the drop in the time-price of bananas illustrates abundance due to human ingenuity. But does the sharp rise in the time-price of baseball tickets illustrate scarcity due to human sloth?
Neither bananas nor baseball tickets are exhaustible resources. The quantities available and the prices at which they are sold reflect the behavior of producers and consumers. Consumption patterns and market structure have made bananas seem more abundant today while baseball tickets seem more scarce.
Agricultural commodities are produced under market conditions. So are many other goods and services. In claiming that living standards have improved, why privilege any one good over the other? There is no reason to treat the time-price of bananas as significant while ignoring the time-price of baseball tickets.
Price Behavior of Exhaustible Resources
Unlike agricultural products, exhaustible resources differ from other goods and services. If the authors of SA had focused solely on oil, copper, and other exhaustible resources, they would have stayed more carefully on point. But they still would be wrong.
As I pointed out above, economic analysis implies that the price of an exhaustible resource at any point in time reflects speculators’ expectations about the indefinite future. In an efficient market, the price of X in any given year should have incorporated all known information at that time. As new information arrived, the price could have risen or fallen.
As an aside, the price of oil has tended to fluctuate more than that of other commodities. Oil has the peculiar property that the cost of “storage” includes the cost of shutting down a well and re-starting it, which can be considerable. As a result, oil prices respond more to short-term shocks than does the price of copper, for example.
As another aside, commodity speculators are bullish under conditions that are pessimistic. War and inflation cause commodity speculators to be especially bullish about commodity prices. Commodity speculators turn bearish during what the rest of us consider to be good times.
When we compare the prices of exhaustible resources at two points in time, we are seeing the effects of surprises that took place in the years between the base year and the ending year. Suppose that in hindsight speculators are too bearish in the base year, meaning that they fail to anticipate the surprises that will raise demand for X in the ending year. In that case, those surprises will drive up prices, and the measures used in SA will suggest that X became scarce in that period. For example, the 1973 oil embargo came as a surprise, so doing a time-price calculation between 1970 and 1974 would show oil becoming scarce.
In fact, the authors of SA use 1980 as a starting point and 2018 as an ending point. This means that they start in an extremely bullish year and end in a relatively bearish year, so that prices of exhaustible resources had fallen from peaks.
The starting year, 1980, was a point at which commodity speculators were very bullish. With inflation raging, commodities were an attractive asset. Many people believed that the “energy crisis” was permanent. In subsequent years, speculators were surprised by falling inflation, lower interest rates, and developments in the oil market that brought in higher supplies and reduced demand.
In 2018, speculators were relatively bearish. More recently, with high inflation and the war in Ukraine, bullishness returned to commodity markets. If the authors used early 2022 prices, their analysis would show much less abundance of oil and other exhaustible resources.
The authors also go back farther in time, to 1900 for example. But at that time, most of the crude oil deposits in the world had yet to be discovered. It is not surprising that as geological exploration and mining techniques have improved, the known supplies of exhaustible resources have gone up. Although we have continued to exploit new deposits (due to fracking, for example), at some point available resources will stop rising.
I am not a doomsayer. I have faith in human ingenuity. But the calculations in this book do not prove that human ingenuity has been at work. The relative prices of produced commodities tell us very little about human progress, either in the past or the future. And changes in the relative prices of exhaustible resources tell us how speculators have been surprised over specific time intervals, with no guarantee that they will be surprised in any particular direction going forward.