This is a different kind of post than the ones that we will usually have during the remainder of the semester. It is longer than usual and much more academic. I decided though that this would be a productive and helpful exercise to introduce you right from the start to a number of ideas that we will be reading and discussing during the next 13 academic weeks. Read the attached and write a thoughtful comment about it. Do not forget to add your name to your comment and make sure that you post what you have to say before the deadline. Anything submitted after the deadline will not earn you any credit.
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The Emergence of Natural Resource Economics
It is in fact quite hard to pinpoint the actual beginning of natural resource economics. The
frame of reference for the early classical economists in the late eighteenth century was a society
that was still primarily based on agriculture, and the productivity of land therefore played
a prominent role in the economics of Adam Smith and his predecessors. In Malthus’ theory
(Malthus 1798), agricultural productivity played a central role in his predictions of the population’s
future standard of living. Some decades later, Jevons (1865) emphasized the scarcity of
a nonrenewable resource (coal) as a constraint on the development of the British economy,
while Alfred Marshall (1890) identified the possible inefficiencies that could arise through
competitive exploitation of a common property resource. The decades that followed saw the
development of economic analysis in relation to both renewable and exhaustible resources. I
will focus my remarks here on a few landmarks in the history of natural resource economics.12
Fisheries as a Common Property Resource
It took some time for other economists to follow up on Marshall’s interest in fisheries as a
common property resource. In fact, in the following decades it was biologists rather than
economists who expressed concern that the organization of the fishing industry could lead
to an outcome that was suboptimal from the point of view of society as a whole. The contribution
that brought fisheries to the attention of the broader economics profession was the
article by Gordon (1954), which described the structure of the fishing industry, constructed a
formal economic model of biological and economic equilibrium, and derived conclusions for
the design of economic policy. In Gordon’s model, fishermen have free access to one or more
fishing stocks and the marginal cost of fishing effort is assumed to be constant. From society’s
point of view, the optimal fishing effort is the level where the value of the marginal productivity
equals the unit cost. However, with free access to the common property resource, the equilibrium
will be where the value of the average productivity is equal to the unit cost. Because average
productivity is greater than marginal productivity, the level of fishing effort will be too high.
In Gordon’s words,
“... the rent which the intramarginal grounds are capable of yielding is dissipated
through misallocation of fishing effort.”
Gordon elaborated on this conclusion:
“This is why fishermen are not wealthy, despite the fact that the fishery resources of
the sea are the richest and most indestructible available to man. By and large, the
12For more detailed accounts of the history of this branch of economic theory, see Robinson (1989) and Barbier
(1989).
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only fisherman who becomes rich is one who makes a lucky catch or one who
participates in a fishery that is put under a form of social control that turns the open
resource into property rights.” (Gordon 1954, 132)
Gordon’s article became extremely influential, particularly in fisheries economics but also in
the broader field of the economics of common-property resources. From the point of view of
the history of economic thought, it is interesting to note that many of Gordon’s results had
already been presented by the Danish economist Jens Warming (1911). However, Warming’s
article was published in Danish and thus failed to reach an audience beyond the Nordic
countries, and his other efforts to present his theory to a wider international audience were
also unsuccessful.13
The Economics of Exhaustible Resources
We have seen that Jevons (1865) was concerned about the consequences of the exhaustion of
Britain’s coal resources. Today, we might wonder why he did not take up the challenge
of analyzing the optimal time pattern of exhaustion. One obvious explanation is that the
theoretical tools required had not yet been developed, although only 6 years after publication
of The Coal Question Jevons himself sketched the principles of utility maximization over time.
Some early efforts to analyze this problem by the use of economic theory did occur during the
next few decades, as for example in Gray (1914), which analyzed the problem of exhaustion on
the basis of Ricardo’s (1817) theory of rent.
However, the great leap forward in this area was in 1931 with the publication of Harold
Hotelling’s “The economics of exhaustible resources” (Hotelling 1931). Hotelling notes that
the world’s diminishing reserves of minerals, forests (sic) and other exhaustible resources have
led to demands for the regulation of their exploitation—as John Stuart Mill (1848) had indeed
called for almost a century earlier. As background to his theoretical analysis, Hotelling points
out that
“[the] feeling that these products are now too cheap for the good of future
generations, that they are being selfishly exploited at too rapid a rate, and that
in consequence of their excessive cheapness they are being produced and
consumed wastefully has given rise to the conservation movement.” (Hotelling
1931, 137)
On the other hand, he argues, it is well known that some of the supply of these resources is
controlled by monopolies and generally accepted that monopolies restrict output below the
social optimum. This view would appear to contradict the feelings prevalent in the conservation
movement that resources are being exhausted too rapidly from society’s point of view. To
clarify this issue, there is a need for a more rigorous theoretical approach that moves beyond the
framework of the static theory of optimal resource allocation. Hotelling argued that the analysis
13Warming’s article was translated into English by Andersen (1983). Warming’s work on fisheries economics is
described in an interesting article by Topp (2008), which also contains a biographical sketch. An important
feature of Warming’s work was that he analyzed the use of a competitive market for quotas as a means of
bringing about optimal resource use in the fisheries.
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of optimal resource extraction must employ the most advanced mathematical tools of dynamic
optimization theory. Indeed
“[problems] of exhaustible assets cannot avoid the calculus of variations, including
even the most recent researches in this branch of mathematics.” (Hotelling
1931, 140)
Hotelling’s Rule
The most famous result to come out of Hotelling’s applications of the calculus of variation is his
“rule” that under perfect competition the net price of a natural resource must grow at the rate
of interest. He compared this equilibrium condition to the result derived from social welfare
maximization (assuming that the welfare function took the form of time-additive discounted
utility) and showed that the competitive equilibrium satisfied the optimality condition.
Hotelling went on to examine a number of extensions of the model that would arguably
move it closer to real-world conditions (such as monopoly resource ownership), and he studied
the implications of the model for economic policy.
Altogether, Hotelling’s “The economics of exhaustible resources” represents a major step
forward in natural resource economics. Given its advanced mathematics, it may have been too
far ahead of its time to have had a significant impact on economic policy when it was first
published. Moreover, in the 1930s, other priorities were at the forefront of policy debates;
Keynesian macroeconomics drew more attention from the profession than the economics of
natural resources. However, with increased concern about resource scarcity in the 1970s,
Hotelling’s contribution received renewed attention from an economics profession that was
now better prepared to consider policy analysis that was couched in the complex language of the
calculus of variations.
Paretian Welfare Economics and Externalities
Pareto’s work became more widely known in the mid-twentieth century and began to be
explored and extended by some of the most prominent theorists of the time, notably
Samuelson (1947), Lange (1942), Little (1950), and Graaf (1957). However, reading these
contributions from the perspective of modern environmental economics one is struck by the
fact that externalities occupy a very insignificant place in them; externalities as a source of
market failure was evidently not considered to be a central element of welfare theory. On a
related point, the typical exposition of welfare economics at the time had much to say about
the marginal conditions required for an optimum (e.g., the equality of the marginal rates of
substitution and transformation) but little to say about the marginal conditions that emerge
from utility and profit maximization in a competitive equilibrium.14 It is clear, however, that it
is in the comparison of these two sets of marginal conditions and in the analysis of the cases
when “prices are wrong” that we find the starting point for the analysis of market failure.
Another notable feature of the welfare economics of the mid-twentieth century is that in cases
14In fact, Samuelson’s justly famous chapter on welfare economics in his Foundations (Samuelson 1947) makes
no mention of market prices and individual optimization.
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where externalities and prices are actually being treated explicitly, the examples that are chosen
to illustrate market failure (e.g., the two agent case of the apple grower and honey-producer in
Meade [1952]), suggest that these are not important issues of concern for a modern industrial
society.
A contribution that is significantly different in these respects is the article by Bator (1958),
which explicitly links externalities to the failure of the competitive price system to capture all the
costs and benefits that are relevant for a socially optimal allocation of resources. In addition,
Bator introduces a separate category of externalities that had not been identified by previous
writers, that is, the public goods type of externalities that could be related to the work
of Samuelson (1954). Writing just a few years before the birth of modern environmental
economics, Bator did not explicitly link this category to environmental externalities; he also
failed to explore the distinction between private goods with externalities on the one hand and
pure public goods on the other.
The Theory of Public Goods
The theory of public goods as first presented in the framework of welfare economics in
Samuelson (1954) is of obvious relevance for environmental economics. The examples of
unspoiled natural beauty and unwholesome factory smoke, as discussed by Mill (1848, 1972)
and Pigou (1920), respectively, fit directly into this framework, as do our present-day concerns
about biological diversity and global warming. Environmental benefit-cost analysis is the
practical application of the fundamental ideas in the theory of public goods. Moreover, the
optimality formula for the efficient provision of public goods—which requires that the sum
of their marginal benefits equal their marginal cost—is reflected in the applied methodology
of environmental project analysis.
However, Samuelson’s analysis was limited to the case of pure public goods, and Bator’s
discussion was along the same lines. In this case, there is no conceptual distinction between
individual and total consumption, and the individual agent has no—or at least extremely
weak—incentives to provide a good whose benefits accrue to a large number of individuals
but whose costs are borne solely by the individual agent. In the case of private goods with
externalities, there is a positive private incentive to consume or produce the good in question.
However, the individual has no incentive to take account of the additional costs and benefits, be
they positive or negative, that arise for all other individuals in the community. Hence, there is
the tendency for goods with negative externalities to be produced in an amount that exceeds the
social optimum, while goods with positive external effects will be underprovided. This type of
case received a lot more attention during the 1960s and after as the separate field of environmental
economics developed. By modeling market failure in regard to the environment as a
case where private goods production or consumption generates public goods type externalities,
it can be shown that the Samuelson sum of the marginal rates of substitution measures not only
the benefits from public goods provision, but also the benefits generated by appropriately
leveled Pigouvian taxes that reduce harmful externalities.15
Thus, when environmental economics first emerged as a separate subdiscipline, a consistent
framework for the analysis of market failure and corrective policies already existed. The further
15This point is made explicitly in Sandmo (1975).
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development of welfare economics was marked by the emergence of second-best tax analysis,
which, among other things, led to the literature on the double dividend. This issue is a concern
of present-day environmental economics and thus moves us rather far from our field’s early
history. Nevertheless, it is important to emphasize that the theory of public goods and externalities
has shown itself to be remarkably robust in its applications to environmental problems,
gradually ascending from the local level of apples and bees to the global problem of climate
change, “the greatest market failure the world has ever seen” (Stern 2007).
Environmental Economics and Public Finance
At this point, a comment may be in order regarding the relationship between environmental
economics and public finance or public economics. Environmental taxation was discussed by
Pigou in the 1920s and explicitly linked to public economics issues in his Study in Public Finance
(Pigou 1928). But the relationship between environmental economics and public finance
received relatively little attention in the academic literature in the following decades. One
striking example of this neglect is Musgrave’s famous treatise The Theory of Public Finance
(1959), which summed up the status of the field at the end of the 1950s. Musgrave devotes little
more than a paragraph to Pigouvian taxation, which does not even mention the environmental
perspective (Musgrave 1959, 115). Even more puzzling, the paragraph appears in a chapter
entitled “The ability-to-pay approach.” This is in sharp contrast to the situation today, where
environmental taxation and benefit-cost analysis are common and, in fact, central themes for
both public finance and environmental economics.
The study of optimal environmental taxation and benefit-cost analysis applies welfare economics
to public policy issues. The Paretian approach to welfare economics derives conditions
for social efficiency and welfare from individual preference orderings or utilities. However, this
approach may become problematic when it comes to examining the effects of consumption or
production decisions on individuals when the consequences are hidden from most people,
acting in their capacity as individual consumers and producers without specialized scientific
information about the consequences of their private choices. The philosopher and economist
Henry Sidgwick noted early on that such cases may call for deviations from the principle of
consumer sovereignty. In his Principles of Political Economy (1887), Sidgwick pointed out that
governments did in fact try to protect their citizens from making unwise choices concerning, for
example, unhealthy or diseased food, unqualified physicians, and hazardous industrial work
processes. In Sidgwick’s view, consumer sovereignty, which he describes as “the fundamental
assumption on which the economic rule of laisser faire partly rests,” should only be accepted
as “a handy though rough rule of practical statesmanship” from which exceptions should
be allowed in special cases. This view has been reflected in many subsequent discussions of
environmental problems, most notably, perhaps, in the current debate about global warming.16
Concluding Remarks
This has been a very selective survey of the early history of environmental economics, and it is
fair to ask whether we can conclude that environmental economics even has an interesting past
16Banzhaf (2011) provides an interesting historical discussion of this issue.
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prior to the 1960s. My own conclusion—which should come as no surprise—is that it does.
Clearly, our discipline has much to learn from the early writings on environmental issues in a
more specific sense, and also from the dependence of the growth of environmental economics
on the more general development of economic theory and methods.
What explains the evolution of environmental economics from its early history of scattered
contributions on a diversity of topics to a fully developed field of specialization in the postWorld
War II period? This is a big and complex question that cannot be fully answered here.
On the one hand, one could cite the growth of environmental problems arising from increasing
industrialization, energy use, and the pressure of population. On the other hand, one could
also argue that increasing standards of living, particularly in the industrialized world, have led to
an increased demand for environmental quality; that is, the appreciation of environmental
goods is income elastic. The interactions between these two sets of factors might go a long way
toward explaining the increased attention to environmental issues in economics.
However, this type of explanation is unlikely to be wholly satisfactory. It took a long time for
economists to start paying attention to environmental issues, even though environmental
problems like those relating to sanitation and public health must have already been pressing
at the early stages of the industrial revolution. One of the reasons for this lack of attention
among economists at the time is likely the widely held view that environmental quality was not
a core issue of economics as a discipline. Another reason for the delay in focusing on environmental
problems must certainly be that it took a long time for economists to develop the
theoretical concepts required to analyze problems of market failure related to the environment.
Thus, the transition to the modern field of environmental economics in the 1960s may
have started with the realization in the economics profession that its tools of analysis had
finally reached the stage where they were adequate to the challenges posed by environmental
deterioration. If this view is accepted, then the transition is an interesting example of what
Tjalling Koopmans (1957) described as the “interaction of tools and problems in economics.”
As he put it, “The solution of important problems may be delayed because the requisite tools
are not perceived. Or the availability of certain tools may lead to an awareness of problems,
important or not, that can be solved with their help” (Koopmans 1957, 170). This perspective
offers a promising approach to further examination of the history of environmental economics.
