Jeremy Grantham vs. Julian Simon

by on May 4, 2011 at 7:48 am in Economics, History | Permalink

Here is nineteen pages of Grantham (pdf), very much exaggerated in tone but useful and sometimes startling throughout.  (I’ve linked to this before but I wanted to pull out some particulars this time around.)  Check out the graph on p.5; most of the decline in commodity prices since World War II has been reversed in the last decade.  Excerpt:

The highest percentage of any metal resource that China consumes is iron ore, at a barely comprehensible 47% of world consumption. Exhibit 9 shows the spectacular 100-year-long decline in iron ore prices, which, like so many other commodities, reach their 100-year low in or around 2002. Yet, iron ore hits its 110-year high a mere 8 years later! Now that’s what I call a paradigm shift! Mining is clearly moving out of its easy phase, and no one is trying to
hide it.

Of course China won’t be devoting fifty percent of its gdp to investment for much longer.  Furthermore, a new technological platform will arise and commodity prices will fall once again.  The question is — when?  It doesn’t have to be soon.  Catch-up growth boosts commodity demands and catch-up growth can outrace TFP-based extraction productivity growth for extended periods of time.  That’s why China can grow at ten percent for decades but we have no real chance of doing the same.  Progress is harder at the frontier.  Julian Simon wrote about how high commodity prices create incentives for new discoveries but he never compared those potential TFP gains to the power of catch-up growth to boost demand and thus high prices; keep in mind The Ultimate Resource first came out in 1981.

Reihan Salam and Robin Hanson predict that, on the energy front, solar power will come to the rescue.  Maybe so, but right now the prices of fossil fuels are robust or soaring.  I don’t read many newspaper stories about the new solar power companies bubble, Spain aside, and that bubble seems to have burst.  How many market prices indicate an optimistic prediction about solar power in the next thirty years?  I find it striking that the two most popular and workable alternatives to fossil fuels are water and wind power (nuclear is not popular, though perhaps workable), which in their essence date from medieval times or earlier.

On Grantham, Paul Krugman offers useful comments, with which I largely agree.  Here is Mark Thoma on decreasing crop yields.  And Tim Worstall comments.

E. Barandiaran May 4, 2011 at 8:08 am

You still don’t get it. In the past 25 years the global market economy has expanded at an extraordinary rate. It has been accommodating between 2 and 3 billion people that had been oppressed by a variety of socialist and communist regimes. This accommodation has implied a large increase in the demand for natural resources and it will take time for production to respond. Unfortunately, in advanced economies governments have been more interested in accommodating the demands of radical environmentalists, delaying the supply response.
It has nothing to do with Julian Simon’s arguments about the ultimate resource. It has nothing to do with Raúl Prebisch’s idea of a secular deterioration in the terms of trade of commodity-producing countries. It is about understanding what is going on rather than debating old ideas out of context.

anon May 4, 2011 at 8:49 am

“Reihan Salam and Robin Hanson predict that, on the energy front, solar power will come to the rescue.”

The total insolation per square meter hitting the earth and the storage problems will never allow solar to fulfill energy consumption at our current levels.

Just not enough sunshine to make terawatts.

Yancey Ward May 4, 2011 at 11:23 am

It may be a long while off technologically, but what hits the Earth is not the actual limit. However, I still think nuclear will be the economically viable option over the longer run.

rluser May 4, 2011 at 11:24 am

10000 square miles in the vicinity of Las Vegas/Death Valley receivesmore (back of the envelope calculation using December insolation) energy from the sun than the entire US consumption of energy. Factor in a current 20% efficiency for photovoltaics and
some margin of safety plus room for growth and it’s clear that the Great Basin could easily meet current US energy demands.

Now you only must decide if it makes sense to work towards it.

Rahul May 4, 2011 at 11:54 am

At what cost though? What’d be the $-per-kWatt and $-per-kW-hr? I’m skeptical that it’ll compete with conventional power plants (at current fossil fuel costs).

Komori May 5, 2011 at 10:56 am

Photovoltaics is a poor way to do it. We’d get much better efficiencies (and costs) by using solar thermal for the large plants.

Andrew' May 4, 2011 at 11:40 am

“The total insolation per square meter hitting the earth and the storage problems”

Which is it?

mulp May 5, 2011 at 3:35 am

quoting http://www.mpoweruk.com/solar_power.htm
The earth receives more energy from the Sun in just one hour than the world’s population uses in a whole year.
The total solar energy flux intercepted by the earth on any particular day is 4.2 X 1018 Watthours or 1.5 X 1022 Joules (or 6.26 X 1020 Joules per hour ). This is equivalent to burning 360 billion tons of oil ( toe ) per day or 15 Billion toe per hour.
In fact the world’s total energy consumption of all forms in the year 2000 was only 4.24 X 1020 Joules. In year 2005 it was 10,537 Mtoe (Source BP Statistical Review of World Energy 2006)

Obviously “The total insolation per square meter hitting the earth and the storage problems will never allow solar to fulfill energy consumption at our current levels.” isn’t based on physics. But economists seem to deny the existence of the natural world and its laws.

Mike Giberson May 4, 2011 at 9:06 am

Haven’t read the paper yet, but the graph on p. 5 you seem to find alarming looks to me to be a great argument for optimism. Since 1900 the price index has tended to fall around 1 percent a year, every so often the tendency to fall is interrupted by events that drive the index back to around parity with 1900 prices or a little above, and after a decade or less of the price index around 1900 levels then the index rapidly moves back to the long run trend. The 110 years in the graph is a period of great expansion in population and great expansion in standards of living, yet we see a general decline in the the price index and only relatively brief interruptions in the decline.

This graph fits a very Simon-esque story of long run reductions in scarcity.

Maybe reading the rest of the 19 pages will overcome a Simon-esque interpretation of the graph, but the graph alone is hardly a discouraging note.

Jeremy H. May 4, 2011 at 7:40 pm

Yes, agreed. There are three other episodes where prices return to 1900 levels, but the long-term trend is down. Of course, the reply might be “well, two of those had to do with major wars, and there is nothing clear about why the current rise is happening.” Perhaps, even though the peaks actually come *after* the wars in those cases. But the 1970s also has no explanation, other than “inflationary oil shock.” Why should an oil shock cause commodity prices in general to rise?

Another confusion I have is with the price index itself. Are these nominal prices? Adjusted for the CPI? Adjusted for wages? Simon was always much clearer about his data, and typically he adjusted them for wages to get a real price. The footnote says that the 33 commodities were “equally weighted at initiation [1900?],” but do the weights change? And why should jute and sorghum be weighted the same as oil and iron? The only source given is GMO itself, but I can’t find anything else on their website or with a quick Google search.

Jeremy H. May 4, 2011 at 8:48 pm

I see in the text that the prices are “after inflation adjustment,” but no further details.

Rich Berger May 4, 2011 at 9:20 am

For a man who has written a book on the Great Stagnation, everything looks like stagnation.

anon May 4, 2011 at 9:44 am

Annoyingly Tyler never has a suggestion about how to fix things. At least those church crazies that tell me the world is going to end in 2012 have some advice.

Marcus Nunes May 4, 2011 at 9:26 am

It´s no coincidence that commodity price declines (iron ore may just be the most visible) reversed direction in 2002. I don´t see it mentioned often, but those trends changed after China became a member of the WTO (December 2001). Since then, it´s international trade has risen more than 7 fold! The impact this has had on emerging market industrial production and so on commodity prices has been huge.
http://thefaintofheart.wordpress.com/2011/02/06/bernanke-and-higher-food-commodity-prices/

Tyler Cowen May 4, 2011 at 10:14 am

Keep in mind, people, that rising commodity prices *are* the *optimistic* scenario, not the contrary!

E. Barandiaran May 4, 2011 at 11:25 am

You’re wrong. The optimistic scenario is that production increases and this requires a strong government rejection of the demands of radical environmentalists. The pessimistic scenario is the status quo because apparently and contrary to what you imply, prices are already high enough to offset any additional effect of income growth on the demand for natural resources (btw, I believe this had already happened in the year before September 2008).

Andrew' May 4, 2011 at 11:47 am

I think you refer to the ‘miracle’ scenario.

E. Barandiaran May 4, 2011 at 11:54 am

If a winner of the Nobel Peace Prize can go ahead with targeted killing and be celebrated by a great majority of Americans and foreign politicians, let me believe in miracles. He may change his mind on environmental policy too.

Do you think he will earn a second NPP?

Andrew' May 4, 2011 at 12:14 pm

Another reason he should have grabbed him alive.

Andrew' May 4, 2011 at 12:15 pm

I guess we couldn’t think of any interesting questions to ask him.

Rahul May 4, 2011 at 11:41 am

I’m lost. So what is the pessimistic scenario? (no sarcasm here)

E. Barandiaran May 4, 2011 at 11:56 am

In my optimistic scenario commodity prices will decline because of increases in production. In my pessimistic scenario prices will remain as high as they are today and they will not decline.

E. Barandiaran May 4, 2011 at 11:58 am

Sorry, rather than “and they will not decline” the last few words must be “but they will not increase as suggested by Tyler in his optimistic scenario”.

ck May 4, 2011 at 12:42 pm

Out of curiosity, what level of environmental safeguarding/damage do you consider acceptable?

E. Barandiaran May 4, 2011 at 4:28 pm

I favor a radical reform of current systems of environmental protection to ensure that ALL costs of a project are effectively internalized by the project’s owners as the only residual beneficiaries of the project. Today’s systems have contributed greatly to what has become another example of the tragedy of the anti-commons –one in which there are several parties with ill-defined “rights” to participate in critical decisions and in controlling performance that weaken greatly the incentives for owners to internalize the costs of the project. In addition, the law must set non-discriminatory, reasonable constraints on the utilization and pollution of natural resources whenever they are enforceable. Reasonable means that law-makers explicitly acknowledge the trade-offs by focusing on a range of values that doesn’t amount to a de facto prohibition of all utilization and pollution.

Andrew' May 4, 2011 at 12:13 pm

I think Tyler is insinuating deflation.

Rahul May 4, 2011 at 2:54 pm

Why would that be bad?

E. Barandiaran May 4, 2011 at 4:46 pm

If any thing, he’s suggesting that commodity prices will continue to rise in relation to other prices. This change in relative prices does not amount per se to inflation or deflation. Inflation or deflation depends on how the nominal prices of goods (other than commodities) and services change. If central banks collude to prevent inflation as measured by increases in some price indexes that combine the nominal prices of all goods (including commodities) and services, then there is a possibility of deflation and a high probability of a recession. if they accommodate the increase in the demand for currency derived from higher nominal prices of commodities, then there will be inflation (this is known as the structuralist explanation of the LA inflation of the post-war period that differed from the fiscal explanation based on central bank financing of budget deficits).

Andrew' May 4, 2011 at 12:14 pm

Or re-suppression.

ck May 4, 2011 at 12:40 pm

Simultaneous economic decline (measured in consumption and living standards) in the majority of the world (as measured by population)– not withstanding whether we are taking about industrialized or developing economies….

Greg Rehmke May 4, 2011 at 10:30 am

The extraordinary low prices in 2002 set the stage for the high prices, as most iron ore production investment was cancelled or delayed. Also, the Chinese communist detour blocked market rates of iron ore use for decades. Had China advanced like Singapore, Taiwan and SK, a lot of iron would have been consumed, (and produced) over the decades. So now a lot of catching up involved. Plus, iron for building is much like copper for new telephone users. Who knows how much higher prices will spur reduced iron use, and what substitutes will emerge?

8 May 4, 2011 at 11:34 am

Isn’t substitution just a marginal advance? You make the big gains up front, and the smaller gains later. Socialism suppressed a lot of gains, which is why China could grow so fast over the past 30 years. However, is there any technology that would be similar to the advance of the steam engine over horsepower? Or the internal combustion engine? Or flight? Most technological improvements appear to be small, and usually energy savings. It seems even solar is looking at marginal advances, is there an expectation for solar to be exponentially more efficient than oil? I’ve heard of 2050 as a target for space-based solar generation beamed back to Earth, but until then, we may face 40 years in the desert.

Sean Brown May 4, 2011 at 11:36 am

Tyler, actually there is a solar bubble. It is just not very well-covered in the English-language press. In 2009-2010 it was in Germany – especially absurd as Germany is a cloudy and wintry country. Now it has moved to Italy (until impending legislation kicks in).

http://translate.googleusercontent.com/translate_c?hl=en&sl=it&tl=en&u=http://www.zeroemission.tv/Fotovoltaico/Fv,-Epia%253A-%2526quot%253BEntro-2015-possibile-traguardo-200-GW-installati%2526quot%253B/news/12240.phtml&rurl=translate.google.com&twu=1&usg=ALkJrhjA7RMDxG0sdQ9EFYHWJnIDXiZTqw

In 2010 Germany installed 7.4 GW of solar capacity.

Or how about http://antioligarch.wordpress.com/2011/03/24/doing-the-math-comparing-germanys-solar-industry-to-japans-fukushima-reactors/ ?

“In 2010, Germany’s cumulative installed solar PV stood at 17.3 GW. In 2009, Germany’s PV solar capacity factor–the ratio of actual energy output over the year and the energy the plant would have produced at full capacity–was 9.5%. This is quite low for solar PV, which typically has capacity factors around 15%, and is likely due to the fact that Germany doesn’t actually get that much sun. If we assume the same 9.5% capacity factor for 2010, then Germany’s 17.3 GW translates into about 14,397 GWh of actual annual electricity generation from solar cells.

By comparison, in 2010, Fukushima’s six Daiichi reactors–which have a nameplate capacity of 4.5 GW–produced 29,221 GWh of power generation.

The German solar industry was built over 20 years with expansive government support. Using an estimate of $5 per watt of installed solar PV capacity, we estimate the country’s 17.3 GW in installed solar capacity to have cost at least $86.5 billion dollars. The actual costs are likely higher, since this estimate assumes 2010 module prices, while costs have substantially declined in the past decade.”

http://www.qualenergia.it/articoli/20110429-fotovoltaico-italiano-la-crescita-non-si-fermera

There are currently a little more than 200,000 solar-panel installations operating in Italy, 197,000 installed under the subsidy regime and 5,000 installed before that.

http://translate.google.com/translate?js=n&prev=_t&hl=en&ie=UTF-8&layout=2&eotf=1&sl=it&tl=en&u=http%3A%2F%2Fwww.pmi.it%2Fgreen-economy%2Fnews%2F8597%2Fstop-incentivi-eolico-e-fotovoltaico.html

The old Italian subsidy regime is about to be overhauled but it seems there were enough applications under the old one to install ~8 GW this year (and I have seen even higher numbers elsewhere). Keep in mind the Italian government had previously set a solar goal at 20 GW by 2020. There was also ~7 GW installed in 2010, so much that half of it couldn’t be connected to the power grid (see link below).

To give some perspective, Italy forces the power grid to purchase solar power at 35-50 Eurocents/kwh, depending on year installed and size/type of installation. This is ~60 cents/kwh vs. 10 cents/kwh national average in the U.S.

http://translate.google.com/translate?js=n&prev=_t&hl=en&ie=UTF-8&layout=2&eotf=1&sl=it&tl=en&u=http%3A%2F%2Fwww.casaeclima.com%2Findex.php%3Foption%3Dcom_content%26view%3Darticle%26id%3D6551%3Ail-gse-conferma-le-stime-sul-fotovoltaico-quota-7gw-a-fine-2010-e-reale%26catid%3D1%3Alatest-news%26Itemid%3D50

E. Barandiaran May 4, 2011 at 12:19 pm

Thanks for you references to ideas that may bring about a solar power bubble. I cannot assess the tech progress in solar power but I know that its production will depend largely on the prices of current sources of energy. To the extent that people realize that the main reason for the high prices of these sources is the uncertainty about what governments will do to prevent or to promote the growth of current sources of energy, investment in solar power will remain low (particularly if it is not subsidized).

Let me add something funny. When I read “solar bubble” at the beginning of your comment, I thought we were moving from sunspots to solar bubbles. To understand my point on sunspots, read this paragraph

“The next major exponent of the Sunspot Theory was the noted English economist, William Stanley Jevons (1835 – 82), who read a paper “The Solar Period and the Price of Corn” before the Bristol Meeting of the British Association in 1875. He stated: “It has lately been proved, beyond all reasonable doubt, that there is a periodic variation in the Sun’s condition, which also marked the occurrences of magnetic stones, cyclones and other meteorological disturbances. Thus rainfall and other atmospheric phenomena are more or less influenced by the same changes in Sun’s condition. Now, if weather depends in any degree upon the solar period, it follows that the harvest and the price of grain will depend more or less upon the solar period and will go through periodic fluctuations in periods of time, equal to those of the sunspots”.
Subsequently, the Garcia – Mata – Shaffner studies of 1934, confirmed the earlier Hershel – Jevons efforts to correlate business and sunspot cycles in terms of an 11-year periodicity as also the 3.5-year periodicity.”

In the early 1960s I studied Garcia-Mata’s theory of the cycles of agricultural prices. Rafael Garcia-Mata was an Argentine engineering that worked closely with well-known economists in the 1930s.

Sean Brown May 4, 2011 at 12:59 pm

Dr. Baradiaran — Thanks for your reply. I have heard from several solar analysts that virtually all new orders for solar modules in France and Italy have dried up since those governments announced “pauses” in their respective subsidy schemes. There hasn’t been much opposition to cuts in France, but many small Italian companies/solar-producing regions are crying that the subsidy cuts will spark massive unemployment and even a recession. (It is true that many installers are employed currently and will be fired due to the unsustainable rate of installation. However this occupation is pretty low value-add, and the increased electricity cost to Italian industry over the next 20 years surely counteracts this.)

Also, if you get a chance could you read my reply to your comment on this post – http://marginalrevolution.com/marginalrevolution/2011/04/my-nyt-column-on-the-euro.html ?

Unfortunately, the final three Real-Barca games didn’t live up to the potential displayed in the first. What a pity.

E. Barandiaran May 4, 2011 at 6:02 pm

1. In Spain subsidies have also been cut but I haven’t heard noisy complaints. Most likely in all countries there are strong pressures by beneficiaries on governments to restore some subsidies but I don’t believe that output and employment will decline as much as claimed by the beneficiaries (they are negotiating). Regardless of how much the cuts affect current levels of output and employment, they will end the expansion of solar power in the three countries for some time.

2. Yes, I read your comment on the Euro the day after you posted. Unfortunately I have not had time to look for research studies of the Eurozone’s overnight interbank market and its importance for the Eurozone’s accounting systems of payments. My impression is that regardless of the insolvency of some banks, these systems of payments will continue to work without any disruption because the ECB’s main responsibility is to ensure that all payments are settled timely. There remains, however, the problem of assuming the losses derived from the outstanding debts. This will be a long process because it is too early to assess their amounts and to determine who the losers will be. One may argue that in Greece, Ireland and Portugal, residents are losers but we don’t know how much their losses will be (and I’m referring only to the direct cost of paying higher taxes or prices for government services and the direct cost of not receiving from the government an income that was considered an entitlement), but they will not be the only losers.

3. Yes, to some extent, the four games were a disappointment. Since I have been following Spanish football for a long time, I can tell you that definitively the main reason for that disappointment was Mourinho’s super-defensive strategy (maybe you have heard about Helenio Herrera –well, Mou was compared to him when he was coaching Inter Milan, the team that HH coached for several years in the 1960s). To make things worse, Mourinho is a sore loser and after the 5-0 defeat to Barcelona last November he has been in a campaign to defame Guardiola and his players with all sorts of accusations, including doping. I think what happened yesterday was a clear reflection of his failed strategy and reflected in the final statistics of the game.

Andrew' May 4, 2011 at 11:51 am

We need every inch of the planet covered with plants or solar panels. I’m not sure that I look at it as replacing anything else.

iamreddave May 4, 2011 at 12:13 pm

This seems to be related to Niall Ferguson’s “let them eat iPads!” claim that inflation is back
http://news.yahoo.com/s/dailybeast/20110502/ts_dailybeast/13790_niallfergusonthegreatinflationofthe2010s

which chimes with TGS on how new technology is advancing but not food and other standard measures of wealth

Floccina May 4, 2011 at 3:50 pm

Even if Commodity prices continue to rise, engineers get for less all the time, that is mostly what they do. Everything has less copper, iron, aluminum, wood etc. in it and our use of energy gets more efficient all the time.

Floccina May 4, 2011 at 3:56 pm

Engineers have been able to increase the efficiency of ICE’s, old technology, 1 percent per year since 1990 and that is with relatively low gasoline prices! HCCI may come out soon plus minimal hybrids and lighter yet safer vehicles. Electronics have just begun to make cars safer at some point they may enable close drafting and thus bring huge highway fuel savings.

Jay May 4, 2011 at 4:26 pm

All of the charts have been adjusted to correct for the plummeting value of the dollar since 2002? has global output of all of the commodities been in real decline (consistent with humanity actually running out of them) or are we simply witnessing price spikes in response to a central bank driven liquidity surge/dollar-devaluation coupled with a decade long global construction bubble of galactic proportions?

If there’s evidence that we’re actually running out of critical commodities at rates which exceed our capacity to adopt substitutes or develop efficiencies that offset the scarcities (at any price level), then the nail-biting might be a bit more defensible…if you’re prone to that sort of thing.

As a Ridley-esque “rational optimist” I have a hard time getting worried about this sort of thing.

jorod May 4, 2011 at 8:44 pm

No scientist or engineer knows any way to replace the internal combustion engine for the next 30 or 40 years.

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Brian May 5, 2011 at 12:54 am

Redoing Jeremy Grantham’s Exhibit 2 in terms of world real income, commodities have become about 58% cheaper in the past 110 years and the CAGR since 1992 is a mere 2.2%. Paradoxically, this might mean that the commodity boom has barely begun or that it never happened.

Brian May 5, 2011 at 2:07 am

Correction that’s 98% “cheaper” in 110 years (flat commodity prices inflation adjusted as in the J.Grantham article, divided by real world income that grew by a factor of 46.1 in the same years).

Ronald Brak May 7, 2011 at 10:12 pm

Solar PV seems like a winner. German solar subsidies have been a gift to Australia and other sunny places by driving prices down to a level that’s becoming affordable. As many sunny locations in the world are quite poor, this could be thought of as foreign aid via other means. Medium sized PV installations are now installed in Germany for around $4.11 a watt. In Australia where we pay around 20 cents a kilowatt-hour for electricity PV installed at that price would give a 10% return in some areas. Now in Australia, even a 10% return isn’t enough for most companies to find it worthwhile to start putting solar cells on their roofs. In general they want a 9%+ net return before they bother to invest. But there are a few factors that are likely to result in a rapid expansion of PV in Australia. The first is spot pricing, which in Australia results in people on average paying considerably more for electricity during the day and much less at night. There is the price on carbon we will soon have here. And there are expected further price decreases in the cost of panels, inverters and installation. And then there is the fact that while our wholesale electricity prices are probably the cheapest in the world, we are really lousy at the distribution side of things. Here distribution costs about twice as much as in the US.

Note that I expect a large scale roll out of solar PV on the flat roofs of commercial buildings and open ground in rural areas where the size of the system can be quite large and the costs of installation per watt low. Putting solar panels on existing residental housing is likely to remain fairly pricey for quite some time.

PV is also likely to be popular in large parts of the developing world where many businesses are currently dependant upon diesel generators for a large part, or all of, their electricity supply. With current oil prices PV is quite competitive with diesel.

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