Economic Wagers and the ‘Ultimate Resource’

A recent article in the New York Times by John Tierney about a current ‘energy cornucopia’ and his winning of a bet on energy resources has brought back to light the famous Simon-Ehrlich wager of 1980 – and sparked a mini-furore in the economic blogosphere and a possible third bet of a similar vein.

Bet 1

Convinced claims made by environmental doom-monger Paul Ehrlich that population growth would quickly outrun the supply of food and natural resources were false, Julian Simon had Ehrlich choose five commodity metals: Simon bet that their prices would go down in real terms, Ehrlich bet they would go up.

The chosen commodities, collectively costing $1,000 in 1980, fell in price by over 57% over the following decade. In October 1990 Ehrlich mailed Simon a cheque for $576.07.

Bet 2

Then in 2005, following in the footsteps of his friend and mentor Julian Simon, John Tierney accepted a bet for $5000 with Matthew Simmons (a former member of the US Council of Foreign Relations and author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy) that the average price of oil for the year 2010 would be less than $200 per barrel.

Tierney and Julian Simon’s widow Rita (who was so happy to see her husband’s tradition carried on that she shared half the bet) were sent their winnings on January 1 this year.

Bet 3?

Since Tierney’s article was published, economist Donald Boudreaux has been trying to organise terms for a third bet in a similar vein with Brad DeLong after DeLong foolishly nominated Tierney, Boudreaux and Mark Perry for the ‘stupidest man alive’ following Boudreaux and Perry’s support of the Tierney article.

No bet

In a comment on a blog I wrote titled Has the ‘Peak Oil’ Drama Peaked?, Steve W wrote that he had challenged Jeannette Fitzsimons to a bet along the Simon-Ehrlich lines during a debate… and that she refused.

The ‘ultimate resource’

Amusing and instructive as it may be, if you put all the gambling to one side it is the ‘ultimate resource’ principle that Julian Simon himself developed in his 1981 book of the same name that is the key to these arguments.

It is a principle that I subscribe to – that humans’ capacity to invent and adapt will overcome scarcity of natural resources.

One way of looking at the basic economics behind the principle is that as a resource becomes scarce, its price will rise. This creates an incentive for people to exercise intelligence and creativity to discover more of the resource, economise on its use and develop substitutes.

In a broader context, it is the ultimate resource because it is limitless – we are constantly discovering solutions to problems once thought insurmountable – and it will never run out.

Mark Perry puts it well:

…the “ultimate resource,” i.e. the human mind, human capital, human ingenuity, and human innovation, are infinitely abundant, and will meet, address and overcome any scarcity in natural resources. The bottom line as I understand Julian Simon is this: we’ll never run out of the ultimate resource. And that is why limited or finite supplies of natural resources have never, and will never, result in any significant binding constraints or limits on human progress, economic growth, or the continual increases in our standard of living, wealth and abundance.

It is also a positive way to think. We live in an age (or perhaps it has always been this way) where people lurch from one fearful impending doomsday scenario to another. If it’s not the ‘silent spring’ or the Y2K catastrophe, it’s ‘peak oil’, ‘acid rain’ or ‘global warming’.

It is reassuring that the historical record shows that humans can and do overcome the obstacles we face.

And of course the ‘ultimate resource’ has countless applications beyond oil and metals.

Consider the amazing work of the American genetic scientist and Nobel Laureate Dr Norman Borlaug who created a high-yield dwarf variety of disease-resistant wheat which, when coupled with modern agricultural techniques, solved the India-Pakistan food crisis of the mid-1960s; turned Mexico into a major wheat exporter; dramatically improved the lot of many other developing nations; and was eventually credited with saving over 1 billion people from dying of starvation.

This was a triumph of the ‘ultimate resource’.

Markets at work – by Top Gear

In buying a new brake calliper for his Porsche James May of Top Gear fame provides amusing but compelling evidence of markets at work (hat tip: Café Hayek). Here’s an excerpt: 

That something as complex as a car can be owned by ordinary people is, I think, one of the greatest achievements of humanity”

I love this stuff.

Working to limits and fits liberates the manufacturing process. Instead of one fitter having to make sets of rods and holes work together, a man in Shanghai can make all the rods while a bloke in Botswana drills all the holes, in the certain knowledge that any two will work together. This is the bed-rock of mass production as far as machines are concerned, if not chicken and mushroom pies.

It’s a pretty simple idea, but it took a long time to sort out. The origins of limits and fits are assigned to the clock-making and gunsmithing businesses, and you can see why they’d be interested, because both these things were required in huge numbers and would break readily – the hammers on guns would shear, and the pallets in the escapements of clockwork mechanisms would wear out.

Prior to the culture of interchangeability, a new hammer for your revolver would have to be made to fit, usually with a bit of filing. The mass-produced hammer would go straight on. Job done.

The earliest cars were made like flintlock pistols, and were machines with no true commonality, even if they looked the same. Each part had to be made to fit by a, well, ‘fitter’, who would remove bits of metal like the man in our original rod-and-hole example. These cars were hideously expensive to buy and hideously expensive to maintain.

It reminded me an article I wrote on productivity titled The Lever of Riches a couple of years ago for the ODT. Here’s an excerpt:

Improving worker training and knowledge, having better technology or more capital to work with, making best use of natural resources and inventing new ways to do things increase productivity. Henry Ford’s development of the assembly line in 1913 is a popular example of a spectacular productivity leap: it reduced the number of hours required to make a car from 17 to one and a half, dramatically cutting the cost of production and making the car affordable.

Ford’s invention effectively pushed his workers up the ‘hierarchy of human talent’. With the creation of machines and tools that can perform tasks better and cheaper than human muscle and basic brain power, people move to jobs that use other, more sophisticated human talents like creativity and people skills. At the same time, manual jobs like sewing machining, assembly line work and telephone operations shift to lower-wage countries where workers can perform them more cheaply. In this way the economy sheds ‘lower order’ jobs, and adds ‘higher order’ jobs like nurses, lawyers, chefs, recreation and hospitality workers, designers and architects, hair stylists and beauty therapists, financial advisors, tourism operators, and so on. 

Read James May’s full article here and mine here.

Donald J. Boudreaux at Café Hayek wonders if James ever read ‘I, Pencil’, a delightful essay by Leonard Read. ‘I, Pencil’ is an old favourite of mine which I highly recommend. The link above includes an introduction by Milton Friedman and an afterword by Boudreaux.