Free Markets and the Man from Fulda

In 1895 a child named Harold Hotelling was born in Fulda, MN.  He took a B.A. in journalism and then decided to study mathematics at Princeton, receiving a PhD in 1924.  He because a professor at Stanford studying math and economics and went on to a very long career at Stanford, Columbia and the University of North Carolina.

Hotelling was largely known for his work in statistics but is also known for working on the economics of exhaustible resources.  In that area, he is best known for Hotelling’s rule, which says that the price of any non-renewable resource must rise by the rate of interest.  Its logic was very simple:  I can always choose to pump a barrel of oil to day, sell it and put the proceeds in a bank account.  Those proceeds collect interest.  Competition means the price of that barrel tomorrow is expected to be higher by a rate equal to the interest rate; if not, you would pump the oil today.

This is not true for the price of renewable energy.  As time passes, the relative price between renewables and nonrenewables falls in favor of renewable energy.  Technology can delay things – no doubt, fracking has made nonrenewable energy cheaper, but only for a while.  Eventually, Hotelling’s rule makes the price of oil and gas rise if market forces are allowed to work.

It’s of course not easy; the technological problems are hard to solve. But as the potential reward rise, in the form of avoiding ever-increasing costs for nonrenewables, the reward to the inventor of that technology rises.  The prize gets larger and more people seek the prize.

From this we know two things.  First, we will never run out of oil, because the price of that last barrel will be so high nobody will pump it.  We will switch to renewable energy long before we get there.  And – here’s the key point – it happens without any government action.  All we need do is wait for Hotelling’s rule to do its work.  Each person, pursuing their own self-interest, would buy renewables because they will be cheaper.

Second, every increase in the price of nonrenewable energy is an incentive to learn better and cheaper ways to harness renewable energy.  Renewable energy is limitless in supply, perhaps, but finding a way to make it do the work we value is scarce:  We must give up something to get that.  The first few times we do it will be expensive because we have not worked out all the kinks, but eventually we get better at it. The incentive to do so is the profit-and-loss system, encouraging exploration and innovation.  Early technologies don’t always meet the market test, but eventually discovery produces something that is widely adopted and the mix of energy changes towards renewables.

Tax incentives or subsidies to produce each, renewables and nonrenewable, are counterproductive to finding the right mix of energy sources.    Artificially raising the prize for solving the renewable energy problems induce investment in technologies that are not sustainable without taxing away the income of all people.  Artificially lowering the price of nonrenewables reduces the prize and discourages innovation.  We don’t want either thing to happen.

Unfettered free markets offer a plan for how renewable energy is developed, as explained to us by the man from Fulda, Harold Hotelling.  Standing in the way of that are people with agendas on both sides.  They should stand aside.

King Banaian 11/16/2017

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