Take Home Assignment ­ Essay

Topic 1 – “The Hartwick rule is useless for daily policy making.”

Prepared for Module CB9008
“Natural Resource Economics”
by
Carlos Ferreira

Submitted on the 30th March, 2009

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 We consider that the production function for a society follows a Cobb-Douglas form

with constant returns to scale:

Qt = Kt Rt , α + β = 1
α β

Where Q represents quantity produced (and, therefore, consumed), K represents

the amount of capital used and R represents the amount of a non-renewable natural

resource used. Being non-renewable, usage of R presents the problem of compromising

future production, due to depletion.

The equation shows that the quantity of R can be almost indefinitely substituted for

capital to maintain a constant level of production over time, As long as α > β. constant

production could result if a specific savings rule – the Hartwick rule – was applied: that at

every point in time the total rent arising in the resource extracting industry be saved and

invested in reproducible capital. This unit rent is the difference between the marginal cost

of extraction and the market price for the resource. These rents are the result of the

Hotelling rule, which predicts that efficient depletion will produce a rent when the resource

is non-renewable. This rent is proportional to the resource's scarcity – it increases over

time, as the resource becomes scarcer.

The Hartwick rule is essentially a behavioural constraint – it forces the saving and

investment of rents in the interest of society at large. Its predicted result is that the total

amount of capital in an economy (natural capital, measured by the amount of the non-

renewable available, plus reproducible capital – physical, human and social) is not

diminished, and therefore production possibilities remain the same indefinitely. Utility,

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measures from consumption – could be maintained over time; this would be a measure of

intertemporal equity (Perman et al., 2003; Hanley, Shogren & White, 2007).

Abstract as the model may seem, there are important consequences to the Hartwick

rule for policy-makers, and indeed some attempts have been made with positive results.

Applying it requires a fundamental change to the concept of economic development;

instead of a game of GDP increase at all costs, development should be conceptualised as

a process of “portfolio management”, whereby each asset is optimally managed and the

wealth is distributed among the different kinds of assets, to maintain or increase wealth per

capita over time.

Lange (2004) compares the evolution of per-capita wealth in two African countries,

Botswana and Namibia, similar in many aspects (size, population, geography and climate)

but different when it comes to management of natural capital: the former features an

explicit policy of reinvestment of all resource rents and an indicator to measure this policy –

the Sustainable Budget Index, which roughly follows the Hartwick rule – while the later has

no specific policies of reinvestment, and has based its GDP growth partly in resource

depletion. Both countries depend heavily on the extraction of natural resources: in

Botswana, mineral exports account for 35% of GDP, 75% of exports and 50% of

government revenue, while in Namibia the combination of mineral and fisheries exports

account for 20% of GDP, 85% of exports and 10% of government revenue.

By using measures derived from the System of Integrated Environmental and

Economic Accounts (SEEA), the study includes measures of natural capital (minerals and,

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where relevant, fisheries), produced capital (private and public) and net foreign financial

assets. Indirect measures of human capital – such as illiteracy rates and response to HIV/

AIDS epidemics are also included.

Taking 1980 as a baseline, Botswana has managed its mineral resources in such a

way that resulted in a five-fold increase in net present value, although 25 to 30% of known

reserves have been extracted. This has been achieved by increasing production over time,

hence discounting less future rents. By contrast, Namibia has suffered similar depletion

rates and has seen its net present value of minerals diminish because of no explicit

investment of resulting rents. Similarly, its fishery resources have been depleted heavily,

and stocks have fallen to a point where recovery becomes difficult.

Equally, the investment of rents has allowed Botswana to increase its produced

capital (both public and private) in the time frame considered, while Namibia has seen a

result in public and private produced capital. Likewise net foreign capital assets: Botswana

has seen an increase of over forty-fold, while in Namibia's case these assets are

frequently negative.

The results of this reinvestment policy (or lack thereof) are clear: Botswana has had

the capacity to invest heavily in reducing the illiteracy rates and, even though it has the

second largest HIV infection rates in the world, it also sports Africa's most efficient and

effective programs to fight the infection and distribute anti-retroviral drugs to the population

(Leithead, 2004), therefore increasing life expectancy and maintaining its stock of human

capital for longer (Langer, 2004). In contrast, Namibia is limited by its lack of capital, and

although the illiteracy rate has dropped in this period, the investment in fighting the HIV

epidemics has been smaller, resulting in Namibia also shedding a large amount of its

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human capital.

On the face of difficult conditions and fighting an epidemics that affects over 25% of

its adult population, Botswana has managed to develop from being one of the world's

poorest countries in 1966 to becoming a World Bank recognised Upper-middle-income

country in the 1990's. By contrast, Namibia adopted no such policies and has liquidated a

large amount of its capital. As a result, its wealth per capita has fallen dramatically, from

being 75% larger than Botswana's to only around one third of that country's by the end of

the 1990's.

It seems clear from this example that the Hartwick rule has important policy

consequences, and should be observed. In the contest between development and

conservation, the best answer is frequently to allow for a socially optimal depletion of

natural resources and invest the resulting rents to ensure total amount of capital in a

certain society does not diminish. Unfortunately, failing to develop policies based in the

Hartwick rule has frequently resulted in the so-called “resource curse”.

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References

● Hanley, N., Shogren, J. F. & White, B. (2007). Environmental Economics in Theory

and Practice. Hampshire: Palgrave Macmillan.

● Lange, G.-M. (2004). Wealth, Natural Capital, and Sustainable Development:

Contrasting Examples from Botswana and Namibia. Environmental & Resource

Economics, 29, pp. 257–283.

● Leithead, A. (2004). Hope out of pain: Botswana's AIDS Story. [Internet], BBC News

World/Africa. Available from <http://news.bbc.co.uk/1/hi/world/africa/3889205.stm>

[Accessed 28 March 2009].

● Perman, R., Ma, Y., McGilvray, J. & Common, M. (2003). Natural Resource ans

Environmental Economics. Harlow: Pearson Education.