Book 1: Capitalism at Work: Business, Government, and Energy

Chapter 10 Internet Appendix

10.1 Hotelling’s Sophism
10.2 The Conversion of Julian Simon
Bibliography: Chapter 10 Appendices

10.1 Hotelling’s Sophism

 

Harold Hotelling became the mineral-resource economist of choice in the 1970s, entirely eclipsing Erich Zimmermann. Hotelling’s “The Economics of Exhaustible Resources” (1931) theoretically explained the profit-maximizing distribution of a fixed stock between time periods under a set of strict assumptions. In an era of rising oil prices, Hotelling’s conclusion that the price of a non-renewable stock must rise in real terms seemed to be the key to understanding reality. No mathematical errors were found in Hotelling’s essay—wasn’t that proof positive of a great contribution?

While Hotelling’s analysis was technically correct, he made two profound mistakes. First, he did not explain why his driving assumption of fixity was misleading for real-world decision-making. Extraction firms and industries are in the business of replenishing supply—of adding to proved reserves and probable resources as they produce from proved reserves. The same firms can purchase reserves and resources as well—another “renewable” option from an economic or business viewpoint.

Second, Hotelling framed his analysis to apply to the real-world debate over depletion, exhaustion, and public policy. He faulted free-market (laissez-faire) decision-making for deviating from the derived optimality in production and pricing. “There are in extractive industries discrepancies from our assumed conditions leading to particularly wasteful forms of exploitation,” he wrote, “which might well be regulated in the public interest” (1931: 143–44).

Yet Hotelling did not make the same point in the opposite direction: thatgovernment intervention may not solve the alleged problem either. Only an omniscient planner would know the specifics of supply, demand, cost, price, substitution, capital, interest rates, technology, and entrepreneurship to implement the “optimal” solution. And political operatives might not implement the efficient solution even if it were objectively known (it is not). Government failure, in other words, should be considered alongside market failure, a point made by Simon Newcomb in the 1880s (1885: 445) and Ronald Coase more recently (1964: 195).

In terms of method and public policy, then, Hotelling’s essay cast more darkness than light on the real-world debate over resource allocation, despite its elegant derivation.

Mainstream economists have wanted to eat their cake and have it too with Hotelling’s Principle. The scarcity premium (“user cost”) concept is presented as invariant but then questioned because of the difficulty of empirically isolating the residual (Griffin and Steele: 73–81). The criticism can be taken a step further: Hotelling’s scarcity premium does not influence market participants and is not economically causal (Bradley: 67–71). User cost does not exist to be isolated and measured.

Hotelling’s essay, the most famous ever published in its field, was misnamed. It should have been titled “The Mathematics of Fixed Resources under Perfect Information,” not “The Economics of Exhaustible Resources.” His contribution was a very special case, not a general one. If this had been appreciated, many economists might not have fallen into the depletionist trap in the 1970s, believing that mineral supply had to decrease over time, and the costs and prices of production rise.

10.2 The Conversion of Julian Simon

 

In 1966, Julian Simon began studying issues of population, resources, and the environment. He began as a Malthusian, fearing more people in a world where the means was fixed (Simon, 2002: 237–40). His conversion to viewing human beings as the solution rather than the problem occurred in 1969, and he achieved full confidence in his new outlook circa 1972/73 (Simon, 2002: 240). He first went public with his contra world view in 1970 (Simon, 1996: 578; 2002: 243), a time that included his Earth Day debate against Paul Silverman (Simon, 2002: 259–64). Simon’s shift was influenced by the statistical inferences he uncovered and by studying the research of others, particularly Harold Barnett and Chandler Morse’s 1963 Scarcity and Growth (242–43).

In 1969, Simon had an epiphany on the way to a meeting with U.S. officials to discuss ways to reduce fertility in less-developed countries. He thought, “Enabling a potential human being to come into life and to enjoy life is a good thing just as protecting a living person’s life from being ended is a good thing” (Simon, 1996: xxxii). He also thought: “What business do I have trying to help arrange it that fewer human beings will be born, each one of whom might be a Mozart or a Michelangelo or an Einstein—or simply a joy to his or her family and community, and a person who will enjoy life?” (xxxi).

Thus did Julian Simon, an open-minded scholar, change his mind on professional and personal grounds and become a determined advocate for his contra-Malthusian view to the day he died in 1998.

Bibliography: Chapter 10 Internet Appendices

 

Barnett, Harold, and Chandler Morse. Scarcity and Growth: The Economics of Natural Resource Availability. Baltimore: Johns Hopkins University Press (for Resources for the Future), 1963.

Bradley, Robert. “Resourceship: An Austrian Theory of Mineral Resources.”Review of Austrian Economics 20 (1): 63–90 (March 2007).

Coase, Ronald. “The Regulated Industries—Discussion.” American Economic Review 54 (3) 194–97 (May 1964).

Griffin, James and Henry Steele. Energy Economics and Policy. New York: Academic Press, 1986.

Hotelling, Harold. “The Economics of Exhaustible Resources.” Journal of Political Economy 39 (2): 137–75 (April 1931).

Newcomb, Simon. Principles of Political Economy. New York: Harper’s, 1885.

Simon, Julian. The Ultimate Resource 2. Princeton: Princeton University Press, 1996.

Simon, Julian. A Life Against the Grain. New Brunswick, NJ: Transaction Publishers, 2002.