This week's lesson involves an examination of a couple of current issues in energy and resource economics: the idea that we are running out of natural resources, and the idea that we should try to avoid importing energy-based commodities and only consume domestically-sourced energy. We will look at the history of environmental pessimism, and then contrast this with what has actually happened over the past 200 years. We will look at some reasons why we might want to avoid using imported crude oil, and why we have failed at this goal, even though it is so frequently talked about by politicians. We will wrap up by looking at some possible alternatives to oil, given the fact that we may choose to not consume it for one reason or another.
By the end of this lesson, you should be able to:
This lesson will take us one week to complete. Please refer to Canvas for specific time frames and due dates. There are a number of required activities in this lesson. The chart below provides an overview of those activities that must be submitted for this lesson. For assignment details, refer to the lesson page noted.
Requirements | Submitting Your Work |
---|---|
Reading: There are several reading assignments hyperlinked in this lesson. Please read all that are shown as required. | Not submitted |
Lesson 11 Quiz and Homework | Submitted in Canvas |
Please read "Special Topic: Are We Running Out of Resources" in Gwartney et al. (no reading in Greenlaw et al.).
An enduring concern, one that continues to be raised time and time again, is that we are running out of resources. This manifests itself in several ways. In the big picture, some people claim that the continuing existence of human beings on the planet is unsustainable - that the rate of population growth that has been observed over the past century will render the earth "full" sometime soon, with the result being a massive reduction in aggregate human welfare.
One of the most comprehensive recent assessments of this issue was written by Lester Brown, a well-known and active environmentalist who has been issuing warnings about our impending decline for many years.
The reference for this article is: Brown, Lester R. Nature's Limit, (Chapter 1) from the State of the World 1995, Worldwatch Institute, Washington, D.C.
In brief, Brown asks: Is civilization about to crash? He is not alone in asking this question - there are many geographers and sociologists that devote their entire careers to studying the “carrying capacity” of the earth, which is the maximum number of people the earth’s resources can provide food and water to.
This number, the maximum number of people the earth can "sustainably" support, has grown over the years with changes in technology, especially agricultural advances. Brown is the champion of the concept of "sustainable development", which refers to a way of life in which humans are "in balance" with nature, and not causing a net draw on nature's resources. The idea being, if we are diminishing the quality of the environment, and continue along the same path, then, inevitably, nature will be destroyed, and the human society that it supports must also fail.
This way of looking at the world is known as "Malthusianism", so named after a 18th-19th century English scholar and parson named Thomas Malthus. Malthus made the observation that while the population of England was increasing at some exponential rate in the early 19th century, the quantity of food being grown was only increasing at a linear rate.
Malthus's most famous work on this issue was entitled "An Essay on the Principle of Population", and a decent summary of "An Essay on the Principle of Population" [1] can be found at Wikipedia (I won't ask you to read the original!)
It is not difficult to see that Malthus was in error: Britain (and the world) has many times the population it had in 1800, but widespread food shortages and starvation have yet to appear. The clear answer is that food production has more than kept up with population growth, to the extent that today the global population has never been higher, but on an average basis the world is consuming more calories than at any time in human history. Why? The short answer is, technology. We'll talk more about this in a little while.
Malthusianism is a strain of what is called "resource pessimism", the general idea that we are forever close to running out of something important, and dooming humanity to either a wretched existence or a miserable end. It is sometimes referred to as "doom-saying". This appears to be somewhat of a built-in human trait, and probably has some value as a survival mechanism, although I am not an expert in psychology and thus will refrain from further comment on that issue. There is, however, an opposite point of view to pessimism and doom-saying, a worldview that is sometimes referred to as "cornucopianism", from the word "cornucopia", which refers to the "horn of plenty', a symbol of abundant food supplies dating back to the ancient Greeks. The most ardent recent advocate of cornucopianism was a University of Maryland economist named Julian Simon. Please read the following article from Wired Magazine, which is a good summary of Simon's outlook.
Regis, Ed. The Doomslayer [2]. Wired Magazine.
In the above article, you will find an explanation of Simon's bet with Paul Ehrlich, a doom-saying environmentalist who claimed that civilization was on the brink of collapse in the 1970s. Simon offered to bet that Ehrlich was wrong. The details of the bet were that Ehrlich would pick any five commodities, and the price change over the period 1980-1990 would be examined. If the prices were lower in 1990 than in 1980, Ehrlich would pay the difference. If higher, Simon would pay. Economic theory tells us that as something becomes scarcer, its price will increase - that is, the cost of supplying it will increase, because it is harder to obtain. Couple this with the fact that as population grows, the demand curve for commodities moves outwards. We learnt earlier in the course that an upward movement of the supply curve coupled with an outward movement of the demand curve would result in a definite increase in price.
Ehrlich chose five metals that he thought we were going to "run out of" in the 1980s: chromium, copper, nickel, tin, and tungsten. A virtual purchase of \$200 of each was made in 1980. By 1990, this \$1,000 worth of metals could be purchased for \$424. The price of each metal had fallen, some in a major fashion (tin went from nearly \$9/lb to under \$4.)
I will note that the consumption of each of these metals increased over the 1980s, while their price fell. Looking back into our course notes, we discover that this is the result of two things: an outward movement of the demand curve coupled with a downward movement of the supply curve. A downward movement of the supply curve means that the cost of producing something has dropped. In this case, the costs of producing each of those metals fell, primarily due to improvements in the efficiency of mining technology.
This takes us back to the notion of sustainability: if we take any current practice, and extrapolate out from the past few data points to some point far into the future, it is almost certain that we will bump up against some sort of system constraint. The fault lies in extrapolating based upon past data, especially recent data, which typically occupy a larger space in one's consciousness than more distant data. However, the world is not linear. As we approach constraints, we change our behavior. When something gets excessively scarce, its price rises, and we choose substitutes. More frequently, we advance technological methods and increase efficiency. A couple of examples: in the first half of the 19th century, the most common source of fuel for domestic lighting was whale oil. As population grew, the amount of whale oil consumed grew, and people began to get worried about humanity killing off all the whales and running out of whale oil. Well, as it turned out, we use basically no whale oil today, and certainly none for lighting our houses. Not because we ran out of whales, but because we developed a substitute, in fact, two substitutes. The first was kerosene, which was derived from petroleum.
Trivia note: petroleum gets its name from the Greek word for rock, "petra", and the Latin word for oil, "oleum", so it was initially marketed as "rock oil", to differentiate it from whale oil. It is like "television" in that it is a word formed from one Greek root word and one Latin root word.
OK, back to the topic: the first major use of petroleum, during the period 1860-1910, was for lighting homes. The automobile did not become the main consumer of crude oil until early in the 20th century. It was a cheap and easier-to-obtain alternative to whale oil. However, it was not without its faults. It gave off vapors that smelled bad and could be dangerous, and having open flames inside a house was often fatally dangerous. Thus, kerosene as a home lighting source was replaced by an even cheaper and easier to use product - the electric light bulb. The whales were saved not by environmentalists or government actions, but by technology, first in extracting oil from the ground, and secondly in building a light bulb that was able to use remotely-generated electricity.
The second example of what appeared to be an intractable resource problem refers to transportation in New York City. At the turn of the 20th Century, New York was a fast-growing city enjoying rapid growth in wealth. One thing people do when they get a little money is travel, and in New York in the 1890s, the most popular form of transport was by horse-drawn carriage. Unfortunately, horses present a bit of a pollution problem: they have, to put it politely, "emissions". The number of horses plying the streets of New York was so great that the city was having great difficulty with the amount of waste product that came from horses: It was difficult to remove manure quickly enough, and the gutters were running full of urine, which attracted a lot of flies and disease and made the city generally a very unpleasant place to walk around, due to the very unsavory aromas. Since the city was growing, it was assumed that the number of horses in the city would grow, and the problem would only get worse. Nobody could imagine a workable solution. Of course, there are far more people in New York today than 115 years ago, but we seem to have solved the problem of horse manure. The answer, obviously, was the development of the automobile. It is perhaps easy to see why the urban planners of 1894 could not see the solution, since it was just in the process of getting invented a few thousand miles away in Europe.
You can read a little bit more about this topic here: Morris, Eric. From Horse Power to Horsepower [3], Access, Number 30, Spring 2007.
The spate of overpopulation doom-saying in the 1970s and 80s has abated somewhat. However, it has been replaced in large part by another type of resource-scarcity pessimism. This is the notion that we are going to run out of energy, specifically, we are going to run out of the fossil fuel energy that powers much of modern society.
This is not a recent development - indeed, questions about the impending exhaustion of a fossil fuel began shortly after we began using fossil fuel. In 1865 an eminent British economist named Stanley Jevons wrote a treatise entitled The Coal Question, where he raised the scary thought that at the current rate of consumption, Britain was due to run out of coal in perhaps 30 years.
A brief summary of the Coal Question [4] can be found at Wikipedia.
I should note that there are still coal reserves in Britain, 145 years after Jevons' essay. That they are not being extracted, and why, is another question we will address shortly.
Petroleum (crude oil) was first produced in commercial quantities in northwestern Pennsylvania in the 1860s. After about 10 years, the Pennsylvania oil fields were largely tapped out - mostly because of poor oil reservoir management - this was the very first commercial oil find, and the people producing it did not understand the proper way to optimize production from an oilfield. Stated simplistically, underground pressure pushes the oil to the wells, and it can either push the oil out of the well, or the oil can be lifted. But we need reservoir pressure to "squeeze' the oil out of the rock. Maintaining reservoir pressure is one of the most important aspects of oil production, but because the early producers did not know this, they drilled thousands and thousands of wells in close proximity to each other, and bled off the pressure in the reservoir, and thus ended the great Pennsylvania Oil Rush. All that is left of it are two famous oil company names - Pennzoil and Quaker State - and a little bit of oil production still in place around Bradford, PA. So, within a decade of the first big oil find, we had the first scare about us running out of oil. We have had many since.
Today, the argument about oil scarcity is addressed under the umbrella of the term "peak oil". This term refers to the idea that the production of oil from an individual oil field, when plotted against time, approximately follows the shape of a normal distribution, whereby it starts low, increases to a maximum value at a peak, and then declines in a symmetrical fashion. The following figure shows what a normal distribution looks like.
The idea that oil production follows such a function was developed by a geologist named M. King Hubbert, and as such are called "Hubbert Curves".
At this point, you can probably guess what I am going to say next. This curve looks very scary: as soon as we pass the peak, the decline will be very fast, and many, many bad things happen as we "run out" of oil, and, of course, there is no shortage of people who believe that we are at the peak, or that we have passed the peak, or we will be over it very, very soon. "The end is nigh", says the man with the sign on the street corner. He may be right one day, but he has not been yet.
Why should we not worry about running out of oil? It seems like an eminently sensible proposition: oil is created very slowly, over hundreds of millions of years, and we are using it up much faster than it is being made. There is a finite amount in the earth's crust, and every barrel we extract means one less barrel in the ground. Surely, this can only mean that one day we will run out; how can it possibly be otherwise?
Your humble professor's contention is that we will never run out of oil. By this, I mean that for the entirety of future human existence, no matter how many thousands or millions of years that may be, there will be oil left in the ground. How so? Why, economics! As the oil in the ground gets scarcer and scarcer, the cost to extract it will increase, and its price will go up. One day, maybe soon, maybe not, the oil that is left in the ground will be so expensive to extract that we will not be interested in extracting it, much like we are no longer interested in harvesting lamp oil from whales. Economic theory tells us, when the price of a good increases, the quantity demanded of its substitutes will increase. One day, oil will be more expensive than the alternatives.
In the meantime, the price of finding new oil has not increased meaningfully over the past 20 years. The market price of oil has gone up and down wildly, gyrating from lows of almost \$10/barrel in the late 1990s to \$140/barrel in 2008 to about \$105 in July 2014, and down to about \$40 in November 2015, and between \$50 to \$60 in 2019 (this changes very frequently). However, much of this price variation is a response to short-term shortages and capacity crunches that are caused by politics, not technology. Much of the world's oil is in places that are hard to get to (offshore, the Arctic), have governments that do not properly reinvest in the oil companies they run (Mexico, Venezuela), have rebel factions that make extracting the oil dangerous and difficult (Nigeria), or choose to voluntarily restrict output to maintain a certain price range (OPEC). However, when one examines the publicly available data on oil lease sales in the US, or the publicly available data on the sales of oil companies (which own oil reserves), it can be shown that the cost of acquiring oil in the ground has not gone up very much recently. This tells us that the difficulty lies with getting the oil out of the ground in sufficient quantities as to keep prices low, and not with finding the oil. The technology for getting oil out of the ground is forever improving - the real obstacles tend to be political, and not technical or economic.
Every time the price of oil rises, we start looking for more, and every time we start looking for more, we find more. If you are interested in looking into this further, here are two words you can give to Mr. Google to see what he tells you: Tupi and Bakken.
So, I am claiming that there is plenty of oil, and we are not near the peak, at least based on available data for the cost of finding new oil. But I also spoke of "substitutes" for oil in the case that we do start to run out. I will talk about these possible alternatives later in this lesson.
One of the enduring aspects of every presidential campaign since 1976 has been the issue of energy security, sometimes framed as "energy independence". This issue leaped onto the public agenda after the First Oil Shock in 1973-4. US consumers saw prices rise drastically in a very short period of time, but more importantly, large shortages occurred, resulting in gas stations running dry, and lines of cars snaking more miles and miles waiting for gasoline. President Nixon fired up a commission to study the issue, and they came up with "Project Independence", an initiative to reduce net imports of energy to zero by 1980.
The results? In 1973, we imported (on net, imports minus exports) about 6 million barrels per day of crude oil and other petroleum products. By 1977, that number was up to about 8.5 million. In the wake of the Second Oil Shock it fell to about 4 million in 1985, but after that it climbed relentlessly for the next two decades, reaching over 12.5 million barrels per day in 2005. Then things changed. The number started to decline. At first, most analysts believe this was due to the great recession, but as the economy started to recover in 2009 and 2010, it was clear that oil imports were still on a down trend. The reason why? The rapid rise in domestic oil production caused by exploitation of tight oil deposits, employing the techniques of horizontal drilling and hydraulic fracturing, which had been developed in shale gas plays. By 2014, net imports were back down to 5 million barrels/day, and it is expected that they will continue to decline over the next half-decade. This number is about 4 million barrels/day in 2018 [6]. Thus, science, technology, innovation and entrepreneurship have worked were government intent failed miserable for two decades, despite each president over that time claiming that "energy independence" was an important goal.
For more details, see the following EIA web page, Petroleum Navigator [7].
I would like to note that the EIA website is an excellent source of information, analysis and statistics about energy production and use in the US and world today. As a professional energy economist and analyst, I probably visit this website about 75% of my days at the office - it is one of the most useful things that the Department of Energy does, in my opinion.
In the late spring of 2011, President Obama pushed this topic to the top of the agenda, with oil climbed back over the \$100 level and gasoline prices exceeding \$4/gallon in much of the country. In fact, with the stated objective of reducing supply shortages (shifting the supply curve and reducing prices), several of the world's governments, including the US, announced plans to release some of their Strategic Petroleum Reserves to the market in June of 2011. This release did have a minimal short-term price impact, but the quantities of oil released were very small- 28 countries together committed to release 60 million barrels of oil. For perspective, the US released 30 million of the barrels, the equivalent of about 1 and 1/2 days of US oil consumption.
So, despite all the talk, we continue to import about a third the oil we burn in this country - another example of actions speaking louder than words. So, why do we do this? Because it makes economic sense, at least at the microeconomic level. We use crude oil overwhelmingly for transportation - it is the most convenient, lowest opportunity-cost transportation fuel we have. Much of its convenience comes from the fact that it has more energy per pound or gallon than any other fossil fuel. We consume this oil because it is the economically optimal thing to do - we want the cheap and easy transportation that we get from oil. We want to drive, we want to fly, we want to have goods shipped by truck.
Normally, this would be uncontroversial: In a market economy, if people wish to purchase the lowest opportunity-cost good out of a range of options, we generally cheer the ability to do so. But there is so much political noise made about reducing oil consumption. Why is this? Some people will point to the fact that there are some externalities that arise from consuming oil - externalities that are not properly included in the price that we pay for crude oil. These include:
Arguments for and against each of these statements can be made. For example, we certainly have lots of regulations concerning air pollution from vehicles, much of which can be found in the Clean Air Acts of 1970 and 1990. This means that our cars and our gasoline are subject to much more stringent regulation than in a "free" market, and we correspondingly pay quite a bit more than we otherwise would for both cars and gasoline. We spoke at length about climate change regulation in the last lesson, so I do not wish to revisit that issue here. To the third point, there are Federal and State gasoline taxes that are designed to fund the construction and maintenance of highways, which is the classic way of dealing with a public goods problem, which is what the public highways are (remember what a public good is - non-rival and non-excludable).
It may be true that a reduction in the importation of oil would allow a reduction in defense spending, but the public does not see any direct linkage between the two, and when we examine the actions of consumers, who are also taxpayers, it appears that the convenience of having plentiful and comparatively cheap oil is something that people are willing to pay for in the form of higher income taxes to pay for a military. I do not recall any politician ever running who promised to reduce military spending if per capita gasoline consumption declined, and I suggest that such a candidate would have great difficulty getting elected. But, that is a political question.
The seventh point bears some more examination. What if we did not import any oil, would we be shielded from global prices? Do a little thought experiment: let's say oil sells for \$50 everywhere. Then the price goes up to \$100 in the rest of the world. Would US producers be happy to sell for \$50, or would they try to sell for \$100 to, say, China or Japan? Obviously, they would try to sell to the highest bidder, meaning, if US consumers wanted the oil to stay here, they would have to bid the price up to match the world price. So, even if we did not import any oil, the price in the US would still move with the world price. The only way to stop this would be to ban exports, which is a practice that runs into opposition with a long history of US trade policy. In order to be "independent" of world prices, we would have to sever trade ties with the rest of the world, a set of actions that would severely harm the country economically.
Thus, you should now have a better understanding, from an economic perspective, of just why politicians talk a lot about reducing oil imports, but why consumers seem more than happy to ship in foreign oil, except when recession hits. We consume oil, both domestic and foreign, because we derive benefits from doing so - more than from any of the alternatives. And there are alternatives - we will talk about this in the next section.
In the previous two sections, I have spoken of two reasons why we might wish to replace oil with some other alternative:
I will you remind you that there is no meaningful indicator that we are anywhere near "running out" of oil, and we mentioned in the previous section that many of the externalities from consuming oil have been partially internalized. The public at large has shown little interest in internalizing the remaining externalities, instead being content to deal with the public-goods issues by taxation methods.
However, it is possible that one or both of these issues will change in the near future. What if we have to replace oil with something, what will it be?
There are five immediate options that I can think of:
This means using less of an input for a given amount of output. In the context of oil, it means using less oil for the same amount and type of transportation. This has been the primary method that has been employed since the 1970s, and is likely to be the most immediate one used in the near future. The major program that has been use is the Corporate Average Fuel Economy program, known by the acronym "CAFE".
In brief, CAFE led to the increase in the average fuel economy of passenger cars from about 14 miles per gallon in 1974 to about 27 MPG by 1985. After several years at the same level, new standards were announced in 2010, with the intent of raising the fuel economy to 34 MPG by 2016 (visit Bureau of Transportation Statistics [8] for the more recent data). Also, for the first time, trucks, buses and other heavy equipment will be subject to fuel economy rules.
You can read all about the proposed rule at the National Highway Traffic Safety Administration CAFE web page [9] (this is for your information only, not required reading).
This is not the same as efficiency, which means using less fuel for the same amount and type of transportation. Instead, this means consuming less transportation or changing the mode of transportation. It can have several manifestations:
Many of these involve substituting travel with non-travel. If we assume that a person derives positive utility from traveling, then replacing travel with non-travel will necessarily result in a reduction of wealth, with the possible exception of the replacement of physical consumption with virtual, electronic consumption. Needless to say, it is difficult to get people to willingly perform actions that will make them less wealthy.
This is perhaps the most obvious alternative. Natural gas is already used in millions of vehicles in South America and Asia. It does not require any major technical alterations to the engines that are currently used to burn gasoline. Another advantage of natural gas is that there are large volumes of it available at very low prices in the US - currently, crude oil costs about three to four times as much as natural gas in the US on an energy basis, that is, \$/Btu of heating energy.
So, the question arises: natural gas is cheap, abundant, domestic, technically feasible, and in use in many other parts of the world. Why aren't we using it? A couple of hurdles: natural gas vehicles either have to have large tanks or short range, and there is not a large infrastructure for refueling. There is also a belief that natural gas vehicles have less performance than equivalent gasoline-fueled vehicles. There are several instances where these issues are not important. For example, all of the buses that run in State College are fueled by compressed natural gas. Taxi fleets, UPS trucks, garbage trucks and school buses are other applications that have seen significant natural gas penetration. The biggest obstacle that people cite is the cost of converting an existing vehicle to natural gas, which is currently on the order of \$1,500-$2,500 per car.
The following website is that of the Natural Gas Vehicle Coalition [10], which is a lobbying group for the adoption of natural gas-fueled vehicles. If you are interested in this issue, there is some good information here, although you should be aware that this website is giving you only one side of the story - that of the boosters of natural gas for vehicles.
A slightly more balanced overview can be found here: Harris, William. "How Natural-gas Vehicles Work [11]," How Stuff Works.
An update: April 6, 2011 saw the introduction of the NAT GAS Act, which is an acronym for The New Alternative Transportation to Give Americans Solutions Act. As you can see, it is very important in today's Washington that every new act have either a catchy name or a cute acronym. No matter. This is an act that largely follows the recommendations of the Pickens Plan, as mentioned above, with the goal of putting something like 250,000 natural gas fueled commercial vehicles on the road, and reducing the amount of diesel fuel (and, by extension, imported crude oil) burned every day. This bill contains a variety of tax incentives designed to grow the tiny natural gas fleet. I should note that the immediate aims are quite modest - currently, natural gas vehicles use about the equivalent of 25,000 barrels of oil per day, or about 0.12% of the oil consumed in the country. This bill would increase that number by 4 or 5 fold, that is, displacing about half a percent of oil consumption.
Replacing gasoline with electricity has two major components: battery-powered vehicles, and long-distance rail powered by electric power-lines.
We are seeing a bit of a boom in electric vehicles at this moment, with about 11 different models available now or in the near future, as listed at the following Department of Energy's web page, New & Upcoming All-Electric Vehicles [13]:
Since almost all electricity is generated [14] by domestically sourced natural gas, coal or renewables (hydroelectricity, wind, ... ), or by uranium that is imported from nations like Canada and Australia, this type of vehicle has the capability to drastically reduce oil imports. There are several reasons why the widespread adoption of electric vehicles may be a bit far out into the future. The first is range: many of these vehicles have a limited range, and will take a long time to recharge. Thus, they will be impractical for long-distance travel. Government data indicate that over 90% of the vehicle trips taken are less than 40 mile round trips, so much of our driving could be replaced by electrics, but people would still need another vehicle for whenever they wanted to drive more than 100 miles in one day. Another issue is cost: an electric vehicle is currently costs more than a corresponding gasoline-powered vehicle, and the payback period extends beyond the life of many cars. The availability of sufficient lithium and problems with battery life are other issues that are yet to be fully surmounted. Nonetheless, as I mentioned above, we are currently in a bit of a boom for this market segment.
Instead of digging our fuel up from the ground, why do we not grow it from the ground? Ethanol, which is created by fermenting a biomass such as corn or sugar cane, and biodiesel, which is made from soybeans, are two types of biologically-sourced fuels that are currently in use in the US. While biofuels are also basically 100% domestic, there are a couple of large issues that may hamper their broad-scale adoption. Firstly, the process of tilling, seeding, fertilizing, harvesting, transporting, processing, fermenting, and distilling ethanol is very energy intensive. The second issue is that corn and soybeans used to make biofuels are corn and soybeans that are not used to make food products. As such, it has effects on the price and availability of food.
Methane derived from the anaerobic decomposition of organic materials. Landfills, wastewater treatment plants, and animal farms (manure) all have the opportunity to capture and utilize this naturally occurring methane. While much of the methane currently captured is being used to power electrical generators, increasingly the biogas is finding applications in the transportation sector. Some large waste-hauling firms such as Waste Management are powering garbage trucks with methane collected at the landfill. In these types of applications, the biogas resembles Natural Gas (see above), and has many of the same benefits and hurdles- conversion costs and distance constraints, for example.
As we can see, there are a variety of options that are currently available to replace crude oil as a transport fuel if we have to. However, as in the case of the automobile that solved the "intractable problem" of horse manure in New York, it is most likely that crude oil will be replaced by some technology, or combination of technologies, that has yet to be invented.
Two features make natural resources different. The first is that such resources are found in nature. From an economic point of view only extraction is required for the generation of wealth. This implies that natural resources require no prior productive processes. When something does not requires productive process then there is no previous productive chain. This means that extractive activity can be developed without strong linkages to society in the rest of the country. Therefore, extractive activities based on natural resources can be conducted in a way isolated from productive activities performed in the country.
The second feature is that natural resources, because they cannot be produced, at some point run out. Thus, they are non-renewable.
Examples of natural resources that reflect these characteristics are oil; minerals like silver, copper, gold, iron; and marine resources that are non-renewable.
The term resource curse represents an economic phenomenon associated with the abundance of natural resources in certain countries. The term summarizes a paradox that those naturally gifted resource countries do not always develop and grow their economies.
It should be understood that if a country has a significant resource allocation, it should use them to their advantage. However, this has not always been the case in many countries with large reserves of resources. In fact, some studies reveal that such resource abundance has been pernicious to countries who own them. It is the meaning of what is termed the “resource curse.”
The term might seem to indicate that the resources themselves are generating the curse, for example, that the goods were not of good quality, or that using them inherently creates harm. However, studies show that the curse comes not in the good as such, but in the use made of them and the conditions of the country, its people, institutions, and authorities that have received plenty of resources.
Following are two use definitions of the phrase "resource curse.”
Karabegovic (2010), states, “In the past, natural resources were thought to create economic growth and prosperity. However, in recent years, debate has flared over whether natural resources, such as minerals and metals, oil, agricultural resources, and so on, stimulate economic growth or act as a hindrance to growth. The idea that natural resources actually hinder growth is known as the “curse” of natural resources.”
Kronenberg (2004) indicates, “The curse of natural resources is a well-documented phenomenon for developing countries. Economies that are richly endowed with natural resources tend to grow slowly. Numerous researchers have found a significant negative correlation between natural resource abundance and economic growth. This finding seemed puzzling at first, because classical economic theory would predict that abundant natural resources should be good for the economy.”
Evidence accumulated over the last 15 years leaves little room for doubting the existence of a ‘resource curse’. Countries heavily dependent on natural resources – geographically concentrated resources like hard-rock minerals, oil, and gas – have performed worse, in both economic and political terms, than countries without the apparent ‘benefit’ of such natural endowments. (Arellano-Yanguas, 2008).
Empirical studies have revealed an apparent paradox: despite a few notable exceptions like the US, the richest countries today are, in general, rather poorly endowed with natural resources. (The word ‘today’ is important here. During the time of the Industrial Revolution and well into the 19th century, natural resources – especially energy sources like running water and coal – were in fact necessary requirements for growth. Apparently, the paradox emerged only in the 20th century. One reason may be that falling transport costs reduces dependence on domestic energy sources.) Most Western European countries, whose economies are based on manufacturing and services, have few natural resources.
Another example is the experience of several Asian “tiger” economies. None of South Korea, Hong Kong, Singapore, and Taiwan, the Asian tiger economies, possesses significant natural resource endowments, but their average growth rates during the second half of the twentieth century have been higher than anywhere else in the world. South Korea and Taiwan achieved this even with difficult political circumstances (Kronenberg, 2004).
One important finding in development economics is that natural resource abundant economies often grow more slowly than economies without substantial resources. For instance, growth losers, such as Nigeria, Zambia, Sierra Leone, Angola, Saudi Arabia, and Venezuela, are all resource-rich, while the Asian tigers: Korea, Taiwan, Hong Kong, and Singapore, are all resource-poor. On average resource, abundant countries lag behind countries with fewer resources. Yet we should not jump to the conclusion that all resource rich countries are cursed. Many “growth winners” such as Botswana, Canada, Australia, and Norway are rich in resources. Moreover, of the 82 countries included in a World Bank study, five countries belong both to the top eight nations according to their natural capital wealth and to the top 15 nations according to per capita income. (World Bank, 1994). (Mehlum, Moene, & Torvik, Institutions and the Resource Curse, 2006)
We discuss two contrasting examples of “resource curse” below.
Venezuela is blessed with oil in abundance. According to the World Factbook, Venezuela is the first of a list of countries with crude oil - proved reserves, and is one of the top producers and exporters of oil in the world. Oil exports account for over 95% of Venezuela’s exports, 50% of government revenue, and 30% of GDP (Rossi, 2011). Clearly, the oil represents the sustenance of life in Venezuela. The government, politics and economy revolve around this natural resource. Yet, Venezuela is living through perhaps its most difficult period since its independence.
In the late-2010’s, challenges in Venezuela are characterized by a poor economic performance, the worst in South America, combined with a lack of stable political institutions, and crisis of authority.
With respect to political institution, while there is a democratic government, this has not meant the renewal or change in the political party that governs the country. Both the deceased President Hugo Chavez and Nicolas Maduro, Chavez’ successor, represent continuity in power which has lasted twenty years.
“Dutch disease” took place in Venezuela in the 1970s when the government, using the money coming from oil exports, made the decision to cancel all agriculture related debt with the hope of eliminating this financial burden and increasing agricultural production. However, the opposite effect took place; most landowners of large farms sold or closed their latifundios (large farm estates) and moved to urban environments where they established other businesses not related to agriculture. Consequently Venezuela (like Nigeria) lost much of its agricultural sector due to its resource wealth. The fall of the agricultural sector and the rise of the oil industry and other service sectors have created high levels of immigration and internal migrations from rural zones to principle cities. These influxes of new arrivals over the years have created high levels of crime, violence, unemployment and poverty in these cities. (Egoávil, 2011)
The country of Chile has had outstanding economic performance, taking advantage of the natural resources it possesses.
Chile produces a third of the copper used in the world. In the past 40 years, Chile has ably handled and channeled revenues from the sale of copper. With the income from the export of copper Chile has prompted the development of other economic activities.
Similarly, decisions that authorities have taken over this time have allowed Chile to successfully lead the transition from poverty to development. In addition, these same decisions have prevented Chile from being affected by the resource curse
At first, given that the mining sector was critical for Chile, the government passed measures to strengthen the sector. The measures sought to create an attractive environment for investment in mining in particular for capital coming from abroad. However, they were not the only measures that were taken. The government of Chile adopted an economic structure with four pillars. The first was the adoption of a predictable and responsible fiscal policy, balancing tax revenues and government spending. The second pillar was the adoption of a monetary policy guided by an explicit inflation target. The third reason was the gradual opening up of financial and trade sectors. Finally, the fourth pillar was to create a solid financial system, private banks and appropriate regulatory policies.
Experience shows that economies with low supply of natural resources have had to deal with limited resources and this situation has pushed them to seek alternative development paths. Those routes to growth and development were based in productive activities rather than in extractive activities. So, having witnessed those experiences, is it possible that economies blessed with resources can use this source as element of leveraging their growth and development? (i.e., can resources be used for growth?) In addition, while the answer must be yes, such a path is likely to be more complex and difficult than one might expect. The complexity and difficulties are due to the many undesirables effects that are involved where there is abundance of resource.
Perhaps one reason is that where there are plenty of resources and things seem to be go well for a country, authorities, population, institutions, etc., become complacent. So, a country’s society does not think it needs to consider more than the extraction and export of the resources. They do not need to think in terms of the long-run, of a goal of creating more sophisticated economy activities,
Therefore, the resource curse is not a path economies must follow. A society can take full advantage of a resource wealth. Taking this path, however, may be difficult and take decades to travel. The path, however, depends on the choices a society makes.
Abundance in natural resources can lead to lower growth rates through several channels: Here we will discuss two: Dutch disease effects; and poor political institutions and poor government policy.
The term “Dutch disease” describes a phenomenon by which the abundance of natural resources in a country becomes in a disadvantage instead of being something from which the country could benefit through the commerce. The mechanism by which Dutch disease is manifested is through international trade. It begins with the abundant natural resources extraction, then is continued in the export of those resources and ends in the inflow of foreign exchange as result of the sale of those natural resources. The term arises from what happened to the economy in the Netherlands after large amounts of natural gas was produced in that country in the late 1960s and early 1970s.
According to World Bank authors, Dutch disease results where, “In places where natural resources are abundant—that is, where they can be produced at low cost, relative to the marginal cost of production elsewhere—they generate large profits (economic rents) for the owners. This has two major effects on the relative incentive structure in the economy. First, to the extent the resources are exported, the inflow of foreign exchange appreciates the real exchange rate: that is, it raises the price of non-tradable goods relative to that of tradable goods. Second, it increases the returns to production of the resource relative to other tradable goods. Both of these effects reduce the incentive to invest in production of other tradable goods, resulting in a production and export structure concentrated in the resource. (Sinnott, Nash, & De la Torre, 2010)
For an example, assume that a country finds it has a lot of mineral wealth – say silver. The silver is mined, and then sold for dollars in the international market. The dollars come into the country and are then converted into the local currency. This raises the value of the local currency with respect to world markets, making wages and local raw material increase in price conducting higher costs for local producers. This drives people out of potentially useful areas, often in the agricultural sector.
In the 1960s, natural gas was found off the coast of the Netherlands. This led to rise in the value of the Dutch currency, making Dutch manufacturing less competitive and harming the Dutch manufacturing sector. A solution could be for a country to give up its domestic currency, like Panama switching to dollars as its currency. However, the drawbacks from such a move could be serious, as what happened in Greece in 2013 after it switched to using the Euro as its currency.
The resource curse may cause the capture of political institutions for ends and interests of those who are active or are located near natural resources. This means that the resource curse affects political institutions, making them serve special interests, reducing their ability to control and supervise economic activity.
The political authorities often collude with private companies to develop projects with the income that comes from the exploitation of natural resources. While these projects may have social purposes, many irregularities often occur. For example, projects are developed with large budgets, equipment is bought with prices above the market, estimated costs increase during the development stage of the project. All these overstatements are ways by which the authorities and private companies receive private benefits from resource extraction.
This behavior leads to what economists call “rent seeking”. This means that there are civil groups, private companies or authorities, which receive income from resources, looking for getting revenues, rents or some money without providing or developing some productive activity.
Recent research shows a direct relationship between the abundance of resources and poorly run governments, poor and weak institutions or administrations led astray by special interests. This is a direct consequence of the behavior of the authorities. The authorities direct their efforts and attention to seeking to stay in power. To remain in power, the authorities use the resources at its disposal looking to catch and supply the needs of their constituents. The regime could also develop economic activities in order to create jobs and distribute them among their potential electors. The result may ultimately be a struggle between the most advantaged and disadvantaged groups, and social unrest.
Loreto, a region in the northeastern Peru, has large quantities of petroleum. The extraction of petroleum is done by companies who pay taxes. A portion of these taxes are allocated to the local governments of Loreto for developing local infrastructure and public services. However, from 2010 to 2013, corruption appears to have taken root in the local government. The authorities of the local government are being investigated to determine the extent of corruption and the use of the funds they received. The supporters of the party in government have claimed that political motives are driving the enforcement efforts. Naturally, the political party out of power has taken a different view of what is going. The resulting confrontation have often taken place in the streets of the province,
Studies about political institutions reveal a linkage between institutions and resource curse as a way in which poor economy performance is encouraged. One of these theories, the theory of institutions and the resource curse (Mehlum, Moene, & Torvik, Cursed by resources or institutions, 2005), tries to explain the impact of “institutional quality” (how well a government operates) in a country that has large natural resource endowments.
The theory focuses on the tension between production and forms of rent seeking. Producers may compete to gain the favor of authorities in order to get benefits from the natural resource. Government officeholders, due to their positions, have the ability to gain rents for themselves. This kind of linkage between institutions and rent seekers lead to impoverish the economy.
Ancash, a region in the north of Peru, is a place that has important quantities of gold and silver. The extraction of these minerals is done by companies which pay taxes as part of its activities. A portion of these taxes are allocated to the local governments of Ancash for developing local infrastructure and public services. However, in the last year, investigators have discovered a net of corruption led by the president of the region. As a consequence, the Ancash Region has gone backwards in its economic development. Much of the local infrastructure has not been developed. The public works that have been built have been made by the companies directly related to the president of the region, or with connections to friends of the president.
In this lesson, we introduced the issue of resource pessimism, aka Malthusianism, the idea that man's existence on the planet threatens nature, and that our continued existence on the planet is "unsustainable." We looked at an explication of this by Lester Brown, and we examined the opposite position, taken by the cornucopian Julian Simon, that life has gotten better on earth over time, and not worse. We looked at a number of historical resource scares, and what the actual outcomes were.
We then examined the idea that the United States should not import energy, but should instead consume only domestically sourced energy. There are several reasons that have been advanced as to why we might want to do this, and several reasons why we have not. We concluded by considering that if we did, for one reason or another, wish to substitute something else for imported crude oil, what would our options be? We looked at five existing options, and finished by considering that perhaps the most likely option is one that we are not aware of yet, as it has yet to be invented.
If you log in to Canvas, you will find the task to be completed for this lesson: an online multiple choice quiz.
You have reached the end of Lesson 11! Double check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there.
If you have anything you'd like to comment on or add to the lesson materials, feel free to post your thoughts in the discussion forum in Canvas. For example, if there was a point that you had trouble understanding, ask about it.
Links
[1] http://en.wikipedia.org/wiki/An_Essay_on_the_Principle_of_Population
[2] http://archive.wired.com/wired/archive/5.02/ffsimon_pr.html
[3] https://escholarship.org/uc/item/6sm968t2#page-1
[4] http://en.wikipedia.org/wiki/The_Coal_Question
[5] https://creativecommons.org/licenses/by-nc-sa/4.0/
[6] https://www.eia.gov/energyexplained/oil-and-petroleum-products/imports-and-exports.php
[7] http://eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=mttntus2&f=m
[8] https://www.bts.gov/content/average-fuel-efficiency-us-light-duty-vehicles
[9] http://nhtsa.gov/fuel-economy
[10] http://www.ngvc.org/
[11] http://auto.howstuffworks.com/fuel-efficiency/alternative-fuels/ngv.htm
[12] https://www.govtrack.us/congress/bills/112/hr1380/text
[13] http://www.fueleconomy.gov/feg/evnews.shtml
[14] https://www.eia.gov/tools/faqs/faq.php?id=427&t=3