Resource Scarcity As A Driver Of Innovation

Until the mid-19th century land was virtually the only economic 'resource', with a few minor exceptions, mainly metals. The idea of resource (land) as a factor of production originated with the French physiocrats, especially Quesnay, and of course the Scotsman, Adam Smith (Smith 1976 [1776]; Kuczynski 1971). Quesnay and Smith were disputing Locke's assertion that land only generates welfare through the application of labor and tools (Locke 1998 [1689]). He regarded tools as a 'store' of labor. Locke's view was the intellectual precursor of the so-called labor theory of value, as refined by Marx and others (Weissmahr 2000).

The notion of land scarcity as a constraint on economic growth goes back to Thomas Malthus (Malthus 1946 [1798]). In the 18th century, when capital primarily meant land, and when most arable land in Europe was already being tilled, it was not clear how a growing population could be fed from a finite supply of land. This was the conundrum that motivated Malthus to write his pessimistic assessment of the consequences of population growth in 1798 (Malthus 1946 [1798]).

Natural resource scarcities, actual or anticipated, have kicked off major efforts to find substitutes or alternatives. There have been a number of cases of actual resource scarcity - or even exhaustion - usually limited to a particular resource or country. To name a few historical examples: charcoal became scarce in western Europe, especially England, by the 17th century, due to land clearing, a building boom and ship-building for the navy.18 Coal came into general use in Britain as a substitute for charcoal in the 18th century. The availability of fossil fuels has been a subject of controversy since 1865 when W.S. Jevons predicted that British coal reserves would be exhausted within a few decades (Jevons 1974 [1865]). Later, other natural resources - and especially exhaustible resources - began to be seen as 'factors of production' in their own right.

Sperm whales, the preferred source of lamp oil and tallow for candles in the early 19th century, were becoming scarce by mid-century. Whaling ships in those days were often away for as long as three years. The increasing scarcity of whales and the high price of sperm whale oil ($2.50 per gallon by the early 1850s, equivalent to $25-50 per gallon today) induced an intensive search for alternatives. Camphene, derived from turpentine, was the early leader. Kerosine derived from 'rock oil' seepages or from asphalt or tar pits (available in a number of places, such as Trinidad) was also in the market, as was animal fat from meat-processing plants. But the combination of ancient Chinese salt-drilling techniques and refining methods already available, prompted the search for, and discovery of, liquid petroleum at moderate depths in northwestern Pennsylvania in 1859 (Yergin 1991). Kerosine, derived from 'rock oil' (petroleum), was the eventual choice from among several possibilities, including lard oil, turpentine and camphene (Williamson and Daum 1959). It remained so until it was overtaken by electric light a generation later. Gasoline was originally a low-value by-product of kerosine (illuminating oil) refining and remained so until about 1910.

Kerosine, derived from petroleum ('rock oil') became the main source of light for the world after 1870. But the loss of its original prime market was just in time to allow petroleum-based fuels to propel automobiles and aircraft. (The year gasoline sales exceeded kerosine sales for the first time was 1911.) Meanwhile petroleum-based lubricants had become essential to the operation of all kinds of machines. In short, the creation of the oil industry was a Schumpeterian innovation in that it spawned or enabled many new industries far beyond its original use.

Acute worries about scarcity arose with respect to petroleum reserves in 1919 and the early 1920s, thanks to the conversion of naval ships from coal to oil and the spectacular rise in US gasoline consumption. The director of the US geological survey even warned that known US reserves would be exhausted in nine years and three months (Yergin 1991, p. 194). New discoveries, especially in east Texas and Oklahoma, converted the anticipated scarcity of the 1920s into a glut in the 1930s. Many petroleum analysts cite that experience to support the thesis that there is still plenty of oil in the world waiting to be discovered.

The Japanese invasion of the Dutch East Indies was prompted by its need for access to oil, for which Japan had been previously dependent on the US (California) as a source. The US cut off oil exports to Japan a few months before Pearl Harbor, probably triggering that event. The German invasion of southern Russia was aimed at the oil resources of the Caspian region. Petroleum became very scarce in German-controlled Europe during 1943-5. In response, the Germans produced synthetic liquid fuels on a large scale by hydrogenation of coal via the Bergius and Fischer-Tropsch processes (Yergin 1991, p. 330). In early 1944 German aviation gasoline was 92 percent synthetic (Bergius) and over half of German oil production through the war period was derived from coal (Yergin 1991, p. 344).

The potential scarcity issue (as applied to oil) was reviewed again in the aftermath of World War II, when the so-called Paley Commission, appointed by President Truman, took up the question in the US.19 It was revived yet again in the early 1970s, even before the Arab oil embargo in 1973-4 led to a brief shortage and a radical price increase that transferred enormous sums from the industrialized consumers into the hands of petroleum-producing countries.20 Major efforts were undertaken in the late 1970s and early 1980s to develop oil shales and tar sands as substitutes for Middle Eastern petroleum. Nuclear power was seen as the other long-term substitute for soon-to-be-scarce fossil fuels until the accident at Three Mile Island, Pennsylvania, in 1979 and the worse one at Chernobyl in the USSR in 1987.

One last example is worthy of mention. The rapid population growth in Europe during the early 19th century that had alarmed Malthus outstripped European agriculture and threatened food shortages.21 A German chemist, Justus Leibig, called attention to the need for fertilizers in agriculture, both to replace nutrient elements (especially nitrogen and phosphorus) removed from the soil by harvesting, and to supplement natural stocks in the soil and thus increase agricultural productivity (Leibig 1876).

Natural fertilizers - notably guano and nitrate deposits from the west coast of South America - were exploited at first, but supplies were very limited. Super-phosphates were made from bones, and later from mineral apatites (phosphate rock). Germans also began to extract ammonia from coke oven gas to manufacture synthetic nitrates. But more was needed. An international race to develop practical means of 'fixing' atmospheric nitrogen led to the development of three processes early in the 20th century. The first was the Birkeland-Eyde electric arc process to manufacture nitrogen oxides. It was successfully commercialized in Norway (1904) where hydroelectric power was cheap. Next came the calcium cyanamide process, based on a high temperature reaction between calcium carbide and nitrogen. The cyanamide subsequently hydrolyzes to yield ammonia and urea. Finally, the Haber-Bosch catalytic process to synthesize ammonia from hydrogen was developed circa 1914. This process soon displaced the others and remains the dominant source of fixed nitrogen for agriculture - and military explosives (Smil 2001).

Modern resource economics began with a famous paper on the economics of exhaustible resources by Harold Hotelling (Hotelling 1931). However, the possible contribution of natural resource inputs to economic growth (or to technical progress) was not considered seriously by economists until the 1960s, especially due to the study by Barnett and Morse (1963) sponsored by Resources for the Future (RFF). The message of that study, which relied heavily on long-term price trends for exhaustible resources, was that scarcity was not an immediate problem, nor likely to be one in the near future, thanks to technological progress.

This conclusion was seemingly challenged by events of the early 1970s, including the 'energy crisis', the rise of OPEC and partly in response to the Club of Rome's 'Limits to Growth' report (Meadows et al. 1972). Neoclassical economists responded immediately with a number of papers disputing the 'Limits' conclusions (for example, Solow 1974a and b; Stiglitz

1974; Dasgupta and Heal 1974). It follows that, in more recent applications of the standard theory (as articulated primarily by RFF and Solow), resource consumption has been treated as a consequence of growth and not as a factor of production (Solow 1986, 1992; Smith and Krutilla 1979). This assumption is built into virtually all textbooks and most of the large-scale models used for policy guidance by governments. We argue a priori that the assumption is unjustified and that energy (exergy) consumption is as much a driver of growth as a consequence.

One of us has argued that a key feature of any satisfactory economic theory should be that it treats materials - extraction, conversion, and use -as essential core activities, not incidental consequences of market functions involving abstract 'resources' (for example, Ayres and Kneese 1969; Ayres et al. 1970; Ayres 1978, 1998; Ayres and Ayres 1999; Ayres and Warr 2002, 2005). Hence resource scarcity is potentially a major concern for us in this book. However, we do not discuss it at length hereafter.

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