Friday Notebook: The New Simon-Ehrlich Teaching Story

Paul Kedrosky has cleverly turned the famous 1980 Simon-Ehrlich wager on future commodity prices into a new teaching story, recasting the old lessons from that economist’s tete a tete into a false moral. In his interview here, with Andrew Keen, Paul explains that not only was the original bet limited to a not-very-useful 10 year timeframe, but worse, a generation of economists interpreted the wager’s outcome as law. Both points are worth making. As Kedrosky correctly points out, once you start moving the 10 year bracket forward from 1980 then Ehrlich, who bet on scarcity and lost, starts to win. Indeed, the winner of the wager was the beneficiary of timing, not insight. But leave it to economists to convert ephemeral conditions into permanent ones. While it’s true that both the price signal and technology can bring forth more supply of resources, often at lower costs, this is only true up to a limit. Once those limits are reached, as we have seen in global Copper and also Oil for example, then better technology might be able to create more supply on a nominal basis, but not at a lower price, and not in real terms. Anyone who has studied the chart of declining ore grades of Copper, or accepted the massive cost escalation in simply keeping global oil supply flat, will understand.

Paul Kedrosky calls the Simon-Ehrlich wager The Bet That Ruined the World. As much as I like that phrasing, I am instead more excited with the possibility that Kedrosky’s recasting of Simon-Ehrlich will now supplant the antiquated, false teaching story originally derived from the bet. As the world now faces up to the fact that no cheaper substitute exists for the uber-dense 5.8 million BTU in a barrel of oil, a recasted Simon-Ehrlich is necessary to usher us more quickly to a confrontation with energy facts, and energy limits. Indeed, for Transitionists who dream of moving quadrillions of BTU demand, currently supplied by oil in global transport, over to a new electrified grid it behooves us to think harder about resources such as Copper. Like Kedrosky, and surely some of my readers, I have marveled over the possibilities of material upgrading and other technological wonders of resource substitution–the kinds of methods that often appear in presentations from places like MIT’s Solar Group. That said, we need to confront the fact that in conjunction with new lows in global copper ore grades, the price of copper–just like oil–has entered a new regime. Expecting a miracle of substitution in copper, or a price reversal downward away from the current regime, is certainly not realistic if we are on the threshold of hitting hard global copper resources to electrify world transport. Simon-Ehrlich recasted is another important step, therefore, towards the realism we need to actually solve the challenge of energy-transition.

-Gregor

  • But What Do I Know?

    Thanks for pointing this out–the bet is just another example of taking a specific data point and concluding from it a universal law. “But history proves it!” the false prophets say.

  • Baba

    Have you considered what substitutes may arise once the price of oil is not kept artificially low?

  • gregor.us

    Of course. Those considerations are behind the writing of this, and many other posts that I write. For example, we do indeed have oil substitutes already in the form of biofuels. Biofuels are of course more expensive, and less-energy dense, than oil. Indeed, organic material contains so little energy density that it barely even registers against oil. There can be all sorts of substitutes for oil. Indeed, if we don't mind negative EROEI there's no barrier to what we can choose. We can turn coal to a liquid, for example.

    Perhaps you had a different question in mind?

    Best,

    G

  • Danny

    Kedrosky raises a fair point, as far as it goes, but it's not as if Simon's results were a complete aberration. The history of commodity prices leading up to the bet — at least if you'll take the classic Barnett and Morse study as a starting point for discussion — were not inconsistent with Simon's hypothesis. Especially when considered as a proportion of wages, natural commodities have been becoming cheaper over most of the modern era. It's possible that this is changing, of course, and that the historical trend is not generalizable to the future. But I don't think it's totally fair to imply that Simon's results are a historical curiosity resulting from the particular time horizon of the bet. I imagine that if you moved the window backwards over the past century or so, instead of forwards, you might find that Simon would win the bet in the majority of time periods. It would also be interesting to know whether Kedrosky's argument is robust to correction for wage levels (not part of the Simon-Ehrlich bet, to be sure, but an important part of Simon's actual argument). If natural commodities are becoming more expensive, but we are becoming richer even faster, then that would seemingly change the nature of the debate on this point.

  • patrickneid

    I'll continue to put my money on Simon. It's a pity he's not here to give us an update. Do I have any empirical evidence to reinforce my support for Simon? No, just the history of Malthusian shriekers (usually closet case central planners). It all makes sense until time goes by and refutes their alarmism. What I do know is crude oil pricing was a bubble that has since burst. Copper currently has all the earmarks of the same albeit an echo bubble it appears. China as usual holds the keys.

    Copper chart
    http://mrci.com/pdf/hg.pdf

    Crude oil
    http://mrci.com/pdf/cl.pdf

    Gold being the next bubble to burst:

    http://mrci.com/pdf/gc.pdf

    The Nasdaq as your guide

    http://mrci.com/pdf/ndxi.pdf

  • Gavin Longmuir

    The future is yet to be written, but if we look back 100 years it is clear the world has improved for almost everybody. Diseases conquered, diets improved, lifespans extended.

    This happened despite the world circa 1910 facing very severe challenges. Something like one third of arable land at the time was used to feed horses, and we were running out of the ability to feed the growing number of horses we would need. Britain was at “Peak Coal”. Doubtless, there must have been many who surveyed the situation and said, “This can't go on”.

    Well, it did not go on! But it was replace by a new technological paradigm which gave more people a better life. True sustainability is based on creativity and technological progress. Worrying about the currently stabilized demand for oil is like those people 100 years ago who worried about what to do with all the horse shit soon predicted to be clogging the streets of London.

    Today ,we know that biofuels are a con — an energy sink that use about as much fossil fuels as they contain. We know that intermittent diffuse wind and solar are Subsidy Sluts — unable to survive without permanent subsidies, the very definition of unsustainable. And we know that nuclear fission works, and can be improved and extended to meet all our energy needs. With enough energy, we can purify all the water humanity needs, and recycle all the copper & iron we need, and manufacture liquid hydrocarbon transportation fuels.

    There is a bright future for any society which honors the laws of physics and pursues technology advance. Unfortunately for western green dreamers, those successful future societies are likely to speak Chinese, Hindi, and Portugese.

  • EB

    I plan on buying a small forest for fuel source before things get Really out of hand. I'll use these contraptions to get around. Lots of good info in the comments section

    http://www.greencarcongress.com/2006/09/everyth

  • Ian_M

    I love this. Zero empirical evidence, just an ad hominem about “Malthusian shriekers”. Helluvan argument, buddy.

  • patrickneid

    Don't let it bother you Ian. Malthusian shriekers is enough evidence. If you know the history you know their track record. They are easy to spot. Paul Ehrlick is a good place to start and you already know Al Gore.

  • Danny

    To be fair, Ehrlich's arguments are far more like David Ricardo's view than Malthus'. If you want to see true Malthusianism in the history of the environmental movement, I'd suggest starting with Gifford Pinchot (e.g., The Fight for Conservation). The differences are important. That's not to defend Ehrlich, of course, and earlier I expressed reservations about this video. But the fact that you don't agree with Kedrosky doesn't justify the sort of bald name-calling you're doing here, especially when you haven't provided much in the way of an argument here (and especially when you misspell “Ehrlich” in your post).

  • I1

    Sure, using the nasdaq as a guide, looks gold's got lotsa room here to run. As does everything else priced in fiat currency. Just as Paul Erlich was wrong during the chosen time frame (since proven correct), Malthus lived before the fossil fuel psycho petri dish blow-off we're experiencing. A few more decades and he'll be proven correct.

  • gregor.us

    Thank you for your thoughtful commentary. I totally agree that Simon was no dummy, and his decision to wager on the side of abundance was wise. Ehrlich, ironically in my view, was working with much less information at the time–indeed, he may have been making a risky conjecture at best, based on his own emerging philosophy. It's even possible that in the context of the day, Ehrlich's wager was “foolish.”

    Seen in the light of a powerful and anomalous 250 year period, however —the period in which we transitioned away from our long stay in an Age of Wood, to coal and oil–there is little if any reason to move the Ten Year Wager bracket backwards by decades, because we already know what we would discover. It's just as you say: Simon would do well in many previous decades.

    What matters now is that, having climbed the ladder of increasing energy density, from Wood, to Coal, and then Oil, there is no next rung to climb on to–not on the crucial level of energy density. And that's what makes all the difference.

    Wrt your comment on wages. Yes, I agree that is an area worth probing, but here we also know that wage growth is very tied in to cheap energy supply. See the work of Robert Allen at Oxford, who shows how extraction of the new coal resource in Britain caused British wages to leap ahead. Indeed, fossil fuels are slaves, and the workers who use them arbitrage wages from them.

    http://gregor.us/coal/the-burden-of-transition/

    G

  • gregor.us

    Thankyou for making the point, with regard to Ricardo. imo, you are very on point in making that distinction.

    Perhaps a faultline that is making an appearance more generally on this topic has a rough correlation to Mercantilism vs the views of Adam Smith, yes? Nota Bene that the ideas of Adam Smith flourished in the era of fossil fuel extraction. His seminal work is published in the same decade (1770's) that British coal mining made one of its greatest leaps forward. And this was still at a time when Britain was struggling to transition from Wood to Coal.

    G

  • gregor.us

    If you wish to place bets along the contours of Simon's view, you really don't need him around to give you an update. That is part of the point: his view is supposed to hold true indefinitely. The constant ability of “innovative” human beings is presumed to trump resource limits and other limits on a perpetual basis.

    G

  • Zmoore

    I don't know why I didn't think about this substitution stuff more. It has been pervasive economic force in my career.

    One, the power industry it has been an immense force, albeit unrecognized by me, perhaps people don't recognize things when they move slowly like innovation in the power system. The first power systems were DC (Direct Current) and used immense amounts of copper. The Edison system used copper buss bars the diameter of an arm to transmit a few killowatts at best a few miles.
    Tesla and Fessenden, funded by Westinghouse promoted the idea of 3 phase AC power. This led to simpler generation but more importantly enabled the use of transformers to create higher voltages. Higher voltages allow one to use the same amount of copper to transmit a more power proportional to the voltage. A 25kvolt line can carry approximately 100 times the amount of the old Edison system. Modern transmission lines are at 250kv or better so carry 1000 times the power.

    Even better, at these voltages, because of the nature of electron flow a steel line with Aluminum outer wires work just fine. Underground cables now are aluminum and plastic with no copper.
    In my City the old low voltage copper heavy system is being replaced by high voltage distribution with flexible switching (and distributed intelligence). This will replace static connections with dynamic high voltage switches.

    In telecommunications old phone lines, both buried and aerial, had large copper cross sections. Electronic amplifiers and compensation allowed them to go from 12ga to 26ga a reduction in ~1/25th of cross sectional area per wire. All interexchange communications (except some really old installations) is
    now done with Fiber optics. So copper price is practically irrelevant now.

    Miniaturization has been the pervasive force in microelectronics enabling a different kind of substitution. A substitution to more expensive materials. The fact that functional performance (memory capacity/computing power)
    have increased by orders of magnitude mean that even the most expensive rare earth elements can be used without much worry over the price. Such little amounts go such long way when you are building transistors at the nano-scale.

    Yes, all of the above have relied on Oil to fund and fuel innovations. And some will point out that Aluminum is really basically expensive frozen electricity. However, there is a payback where a MIP (million instructions per second) now costs a nanowatt in power and a few cents whereas not too long ago it cost a few kilowatts and in the case of the IBM 360 a million dollars per cpu core.

    The net of what I'm saying it that substitution can be a, albeit creeping, black swan which changes everything.