Lecture 23: Sustainability

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Lecture 23 Sustainability
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Sustainability in Economics

• In economics, an economy is sustainable if
  future generations will be able to enjoy the same
  standard of living as the current generation.
• Work by Hartwick (1977), a Queens natural
  resource economist, and others has identified a
  necessary condition for economic sustainability
  that a nations capital be kept intact.
  Capital here refers not only to physical
  capital but to any stock from which services
  flow.
• The intuition behind keeping capital intact is
  that, in order to have a constant stream of
  income into the future, you need to have a
  constant amount of wealth from which to earn
  income. If you want to keep drawing interest out
  of your bank account, you must not dig into the
  principal.
• If population grows, national wealth or national
  capital must actually increase so that the
  capitallabour ratio is kept intact.

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The Basic Model

• In the 1960s and beyond, economic growth was a
  hot topic, and economists used a highly
  simplified model of the economy, based on the
  aggregate production function Y GDP F(K,L).
• This is called the neoclassical production
  function.
• All inputs are essential
• Even at very high prices, all inputs will be used
• Inputs can drop very low there is no threshold
  level of input necessary (Daly criticizes)
• All inputs are substitutable to some degree.
  (Daly criticizes)
• Inputs engage multiplicatively synergies
• Constant Returns to Scale.

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• In these growth models, part of Y is eaten, and
  the part not consumed is invested in K. So we
  have another equation I Y C.
• Robert Solow (1974) used Y F(K,L,R), where R is
  an exhaustible resource like oil. S is the total
  stock of oil, and S falls every year by amount
  R(t).
• Solow showed that, if there were no population
  growth, and
• if there
  were no depreciation of K, then
• a constant level of consumption (or consumption
  per person) could be sustained indefinitely.
• John Hartwick (1977) showed what was going on in
  the math. The amount being invested (not
  consumed) is equal to the rents from resource
  extraction.
• Hotelling rent is the difference between the
  price of the marginal ton of oil extracted, and
  its marginal extraction cost.
• Hartwick has shown that if I Hotelling rent R
  total Hotelling rent (THR), then the value of K
  R is being held intact, and consumption is
  sustainable. S ? K?
• This is known as Hartwicks Rule

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• Hartwick showed that, if resource rents were
  reinvested in physical capital according to
  Hartwicks rule, consumption could be sustained.
  
• As recently as this year, it has been shown that,
  if more than resource rents were reinvested in
  physical capital, consumption could grow. In
  fact, for every extra amount reinvested implies a
  level of population growth that would be
  manageable at a constant per capita consumption
  level. The population growth is not geometric,
  however. It is quasi-geometric. N(t) a
  b(t)
• Unfortunately, to get their sustainability
  result, the math still requires that there be no
  physical depreciation of capital, which is
  completely unrealistic.
• However, if there is enough exogenous technical
  change, then physical depreciation of capital is
  not a problem.
• Of course, if there is enough exogenous technical
  change, you dont even need to invest resource
  rents.

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Different kinds of capital

• Physical capital. Declines due to depreciation
  and due to shallowing (when population grows).
  Neither is a problem so long as a sufficient
  amount is saved. Output per worker can be kept
  intact. However, if the population growth rate
  increases, more must be saved, so consumption per
  worker falls.
• Exhaustible Resources. The stock of an
  exhaustible resource like oil declines as it is
  used. Output per worker can be maintained if THR
  is invested. If more than THR is invested,
  arithmetic population growth can be tolerated.
  If either depreciation occurs or population
  growth occurs at a constant rate, output per
  worker cannot be maintained.
• Renewable Resources. Renewable resources can be
  harvested sustainably. The optimal amount to
  harvest each year depends on demand, supply, the
  interest rate, and the biological growth rate of
  the resource. However, renewable resources are
  often over-harvested for lack of oversight and
  ownership. We may also be ignorant of some of
  the biological factors needed to determine the
  biological growth rate. As the population grows,
  demand will grow, and the maximum sustainable
  yield will be reached. At that point we may have
  to make up for declining harvest-per-person by
  investing in physical capital à la Hartwicks
  rule. (see point 2 for results).
• Environmental Capital. Pigouvian taxes
  politically unpopular can in theory prevent the
  deterioration of environmental capital. However,
  environmental capital typically does not grow.
  There is a finite amount of clean water and air.
  To make up for environmental shallowing due to
  population growth, Hartwicks Rule-type investing
  will be needed. See point 2 for results).

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Is any nation using Hartwicks Rule?(you do not
need to know this for exam).Ref. Martin Skancke,
Workshop on petroleum revenue management, 2006

• Alberta taxes private owners of mineral deposits,
  and collects royalties very similar to taxes
  from those working Crown deposits. The royalties
  depend on price and volumje (gas oil) or
  profits (oil sands). From 1976-1983, 30 of
  government revenues from the energy sector were
  placed in the Alberta Heritage Savings Trust
  Fund. That shrunk to 15, then ceased in about
  1988. Recently, the Fund has been restructured,
  but Im not aware of any dedication of energy
  sector earnings to the fund. Recently, 400 was
  paid to each Albertan to represent their share of
  oil and gas revenues from Crown land. This kind
  of payment is not scheduled or required by law.
  Albertans are now considering a regular citizens
  dividend from moneys placed in the Fund.
• According to the Norwegian Ministry of Finance,
  several oil-producing countries have some kind of
  fund paid for by taxes on oil and gas revenues or
  a share of the governments budget surplus.
• Chile and Venezuela use the money to stabilize
  the government budget, which is very sensitive to
  variations in oil and gas tax revenues. There
  are not necessarily any public savings over the
  long run.
• Alaska and Kuwait have savings funds which are
  separate from the government budget. Alaska
  gives about half the interest earned on the fund
  back to the citizens in the form of a yearly
  cheque.
• Kuwait, East Timor, and Norway have financing
  funds which pay for government deficits. Here it
  is obvious when the net savings of the country
  are positive or negative.
• According to the CIA World Factbook, Norways
  Government Petroleum Fund is currently valued
  at 250 billion, which is equivalent to about 1
  years GDP.
• Norway uses part of its fund to buy foreign
  exchange so that Norways krone will not
  appreciate too much due to demand for Norwegian
  oil and gas. When demand for your major export
  commodity causes your currency to appreciate,
  your other export sectors are injured. This is
  known as Dutch Disease.

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• Hartwicks rule is that resource rents must be
  reinvested in physical capital.
• Ignoring the depreciation of physical capital for
  a moment, there must be investment I gt THR, else
  total capital is declining due to the running
  down of the exhaustible resource. I THR is
  called economic depreciation.
• There is a similar number that can be calculated
  for countries which exceed their optimal harvest
  of renewable resources.
• Normally, statisticians collect data on GDP or
  GNP each year. They also calculate NDP or NNP,
  which subtracts physical capital depreciation
  from GDP or GNP.
• Green NDP or NNP would go one step further and
  subtract economic depreciation from NDP or NNP.
• So we see that a nations capital base can be
  run-down (depreciated) or built up
  (savings/investment).
• A country may be investing a lot, but its
  resource base may be depreciating even faster.
  An economy needs genuine savings in order to be
  sustainable.

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Genuine Savings

• Genuine Savings was calculated for various
  nations in a 2006 publication of the United
  Nations titled Where is the Wealth of Nations?
  Measuring Capial for the 21st Century.
• Gross National Saving (GNI C G ), where GNI
  is approximately equal to GDP
• minus the depreciation of physical capital Net
  National Saving
• Net National Saving
• plus current spending on education
• minus an approximation to Total Hotelling Rent
• minus health and other damages from pollution
  (the authors included a charge of 20 per ton for
  CO2 emissions)
• Genuine Savings

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Genuine Savings, 2000, As of GNP

USA, Canada 8.2, 12.7
Australia 4.3
Denmark, Norway 14.8, 18.5
Ireland 22.7
Romania 3.3
Kuwait, Saudi Arabia -12.9, -26.5
Mexico, Bolivia 8.4, -0.6
Haiti, Dominican Rep 26.1, 14.2
Kenya 10.9