Economist vs. Environmentalist

Natural resource usage has been the topic of hot debate for years. While environmentalists have led several widely-publicized predictions on how we are running out of natural resources, economists have a contrasting perspective. The infamous bet between economist Julian Simon and environmentalist Paul Ehrlich demonstrated the difference between the economic approach and the hysterical approach to natural resource usage:

Professor Simon offered to bet anyone that any set of five natural resources they chose would not rise in real cost over any time period they choose. A group led by professor Ehrlich took the bet and chose five natural resources. They also chose ten years as the time period for measuring how the real cost of these natural resources have changed.

What do you think happened? Most people would be very surprised at economist Simon for his bet offer. We all think that as we use up natural resources at this unprecedented rate, they are going to run out and consequently, the prices are going to rise. But have we ever really considered this approach that we are considering? Let’s take a look at what really happened with the bet:

At the end of the decade, not only had the real cost of the five resources declined, but so had the cost of every single resource they predicted would rise in cost.

How did this happen? The simplest way to explain it is that while most of us have taken the hysterical approach to this issue, we have ignored the economic aspect of it. Just as shortages and surpluses cannot guarantee the quantity of physical material, known reserves of natural resources are not simply the matter of how much physical substance is in the ground. For natural resources especially, prices and present values are crucial.

Take oil for example. As the oil on the surface is running out, companies start to explore oils underground or beneath the ocean floor, which will cost them more to produce. These companies will keep producing oil until the cost to produce the next barrel exceed the profits they can make. In other words, until the marginal cost becomes equal to the price.

As more and more of the known reserves of oil get used up, the present value of all remaining oil begins to rise, and once more, exploration of the oils that are more costly to produce become profitable. This creates incentive to improve technology, and in turn makes the oil discovery and extraction more efficient. As energy usage continue to escalate, exploration is heightened and technology improves, thus leading to the discovery of more reserves and the fall in price once again.

“In some ultimate sense, the total quantity of resources must of course be declining. However, a resource that would run out centuries after it becomes obsolete, or a thousand years after the sun grows cold, is not a serious practical problem. If it is really going to run out within a time period that is a matter of practical relevance, then the rising present value of the resource whose exhaustion looms ahead will automatically force conservation, without either public hysteria or political exhortation.”

There may be enough oil underground to last for centuries, but its present value determines how much oil will repay what it cost anyone to discover it at any given time — and that may be no more than enough oil to last for a decade or so. A failure to understand this basic economic reality has, for generations, led to numerous false predictions regarding our shortage of natural resources.