A note on the Simon-Ehrlich Bet

by on December 24, 2010 at 7:10 am in Economics | Permalink

Yesterday Tyler asked whether "Simon's prediction" of falling resources prices would continue to hold now that an era of catch-up growth is upon us. It's a legitimate question but misleading about what Simon was predicting. Simon's fundamental prediction was about human welfare not prices. Remember that at the time of the famous bet, Paul Ehrlich was predicting increasing resource scarcity, mass starvation, and an end to economic growth. Simon was arguing that human welfare would continue to rise. Resource prices were easy to observe so the famous bet was made in terms of prices. Simon understood, however, that prices are not a measure of welfare or even of scarcity (quantities would have been a better metric but these are much more difficult to observe).

As Tyler notes, catch-up growth may mean that demand will increase faster than supply at least for some periods thereby driving up prices. But here is the key point, increased demand with a non-decreasing supply means an increase in social welfare. If tomorrow we discover that cold fusion actually does work, the price of palladium will increase dramatically, perhaps never to fall again.  Nevertheless, human welfare would dramatically rise not fall.

I don't have strong views on resource prices over the next century (especially when these are framed in terms of specific resources like "oil" rather than with the more fundamental concept of energy) but I would be happy to bet that human welfare will increase dramatically over the next century.

Ci-Sun December 24, 2010 at 5:08 am

Maybe we have been reincarnated as a Spanish or African raider bent on getting to the green and fertile promised land with the temperate climate and the generous civil service remuneration.

Lord December 24, 2010 at 5:45 am

Even if palladium rose, many, many, other resource prices, more important ones, would fall dramatically as a result, so prices are a reasonable welfare measure.

Indur M. Goklany December 24, 2010 at 10:30 am

I tend to agree with Alex. As noted in a series of posts titled, “Population, Consumption, Carbon Emissions, and Human Well-Being in the Age of Industrialization” which commenced with a piece Revisiting the Julian Simon-Paul Ehrlich Bet on MasterResource, I note that:

1. Real prices miss out on a critical factor. Because wages and income also change over time, prices should be adjusted to reflect changes in wages or incomes. Defining Affordability as the ratio of average per capita income or wages to price, the post presents graphs which show that metals and food are more affordable today than 50, 100 or even 200 years ago (for metals).

2. “There is no guarantee that will continue into the future. But that is beside the point. If a brand new use of great benefit to humanity were to be devised for an old commodity, one should not be surprised if its price were to rise. But instead of signaling a worsening of human well-being, that would indicate an improvement (in well-being). The real issue is not whether commodity prices are going up or down but whether human well-being is going up or down.”

3. Thus, the price increases in the early 2000s, due in large part from catch-up growth:

should be viewed as a victory for humanity rather than with dismay. It was fueled by an increase in demand in developing countries, mainly China and India, as they joined the rest of the world in benefiting from modern economic growth. This demand drove — and was driven by — the economic development that has turned out to be the most effective poverty reduction machine ever devised. From 2002 to 2005, … the number of people living in absolute poverty in developing countries declined by 230 million (from 1.60 billion to 1.37 billion) despite a population increase of 210 million. Higher commodity prices for the affluent West seems to be a minor inconvenience in light of that (see below).

Omri December 26, 2010 at 7:11 pm

" But here is the key point, increased demand with a non-decreasing supply means an increase in social welfare. If tomorrow we discover that cold fusion actually does work, the price of palladium will increase dramatically, perhaps never to fall again. Nevertheless, human welfare would dramatically rise not fall."

That example is such an outlier it doesn't bear much thinking about. How many metals that have risen in price since 2000 fit this example? Lithium, arguably. Neodymium, perhaps.

A more general example is copper. As billions of people aspire to a Western standard of living, the price of copper rises. That rise is an indication of improvement in their well being.. But when the amount of copper arriving at the market fails to rise in response, then those billions don't get their aspirations. And then the price is an indication of billions of unhappy Chinese and Indians.

Or, we can just admit that the price of copper is not a sufficient indication of anything about people's standard of living, and we should obtain more data.

Mercy Vetsel January 9, 2011 at 10:32 am

Sheesh, you'd think these economists would be smart enough to check the ***MARKET*** before making bets. Apparently DeLong is too stupid to do so, because he is essentially offering to bet that the price of oil right now is $103. That is $15 above the market price.

That's not surprising since he's so suspicious of markets and legendary for skimming over minor details when he reads, but I'm baffled at Boudreaux's delay in accepting the oil-only bet.

On Friday the futures for oil delivered in Dec 2019 were going for $95.86. Compared to the price for Feb 2011 that's a 0.9% discount rate for the next nine years. Based on the implied inflation from 10-year TIPS, the threshold for winning the DeLong bet will be about $111, but you can enter in a futures contract at $96.
http://www.cmegroup.com/trading/energy/crude-oil/

So make the bet and then go long the futures contract and sit back and wait to collect your risk-free arbitrage profits.

It's one thing to win a bet based partially on random movements, but winning a risk-less bet because DeLong is too stupid to check the market — THAT would be priceless, especially if he were bested by the "stupidest man in the world."

-Mercy

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