Weitzman says that current income need
be adjusted downward by 1 percent at
most to account for the loss of exhaustible
In a finite world, the conventional wisdom tells us that we shall eventually run out of nonrenewable resources, such as crude oil, iron ore, and bauxite. And long before exhaustion actually takes place, this same wisdom informs us, the growing scarcity of these resources will limit our ability to consume. These views have led to fears of “running out of oil” and have even spawned books and movies depicting the resulting chaos. Yet according to recent research by Martin Weitzman (1999) of Harvard, the economic impact of exhausting nonrenewable resources is far less important than you might think. Indeed, it appears that by failing to explicitly account for exhausting such resources, we are overstating our welfare by one percent at most.
Because the earth is finite, physical stocks of nonrenewable resources must shrink over time. Barring other developments, this reduction in supply tends to push up the prices of these resources. People respond to these higher prices by using other factors of production instead, but this means devoting more and more of other resources to coping with the disappearing nonrenewable resources. We somehow must account for this coming rise in scarcity if we are to accurately judge our current well-being.
For example, when the price of oil rises, we can adjust by developing more fuel-efficient cars. But this comes at a cost, a more expensive new engine. This cost is not properly reckoned with by orthodox income measures. The cost of developing the improved engine is conventionally counted as part of income yet it represents an expense that would be unnecessary if oil were renewable. And so, the question is, by how much are we worse off because some resources are in fact nonrenewable?
The answer, it turns out, is fairly easy to calculate: We need only adjust current income, measured as net domestic product, downward by the value of the nonrenewable resources exhausted in creating that income. For example, in one recent year, the world used up about ten metric tons of silver. Its market value after deducting extraction costs was $40 million per ton. Thus, to account for the nonrenewable nature of silver, $400 million should be deducted from world income figures.
The logic of the Weitzman adjustment is much like what economists already do when they go from gross domestic product (GDP) to net domestic product (NDP), accounting for the depreciation of the capital stock. When output is produced, some of the capital is used up–it depreciates. If we want to continue to produce at the same rate, the capital stock will have to be replaced. Net domestic product adjusts for this; GDP does not. Weitzman has devised a way to make a similar adjustment to net domestic product to account for the exhaustion of nonrenewable resources.
In effect, the income that nonrenewable resources seem to generate is merely temporary–it cannot be sustained forever. So if we want a measure of our permanent income–that which can be sustained for generation after generation forever–we must deduct this temporary component from net domestic product. Weitzman does this computation for the key exhaustible resources, ranging from bauxite to zinc, and crude oil to iron ore. His conclusion is that current income need be adjusted downward by only about one percent to account for the gradual loss of exhaustible resources. The key players in this calculation are the energy resources: oil, natural gas, and coal. Crude oil accounts for half of the necessary adjustment to income, and the combination of oil, gas and coal amounts to about 90 percent of the total.
There are two ways to judge the significance of Weitzman’s one percent figure. Current income also fails to properly reflect our wealth because it does not account for future growth due to technological progress. On this account, current income tends to understate–by some 40 percent–a more accurate measure of income that would account for the importance of future technological change. This understatement obviously swamps the effects of nonrenewable resources. Or, as Weitzman puts it, “policy concerns about running out of [exhaustible resources] should carry only about one-fortieth the weight of policy concerns about the effectiveness of R&D” (705).
If this seems to be a large role for technological advance, it must be remembered that over the last century, humankind’s ingenuity in getting more from less has had a peculiar, albeit salubrious, effect in the area of exhaustible resources: For most of these resources, economic (as opposed to physical) supplies seem to be growing. Proven reserves are getting larger, and, as witnessed by the famous bet between Paul Ehrlich and the late Julian Simon, prices of many nonrenewable raw materials have been stable or falling. Thus, though we may not be quite as rich as we think we are, it appears that we also are not nearly so rich as we are going to become.
Another way to view Weitzman’s results is to think in terms of per capita income in the U.S. today. Adjusting income down to account for nonrenewable resources means we should knock off about $250 per year for each man, woman, and child in the U.S. Although this is a sum surely worth contemplating, it is not something–in my estimation–that merits donning a hair shirt.
Weitzman, Martin. 1999. Pricing the Limits to Growth from Minerals Depletion.Quarterly Journal of Economics 114(2): 691-706.
Daniel K. Benjamin is a PERC senior associate and professor of economics at Clemson University. His regular column, “Tangents-Where Research and Policy Meet,” investigates policy implications of recent academic research. He can be reached at: firstname.lastname@example.org