Hotelling in Brasilia

Girogi - Dois Candangos Monument in BrasiliaHarold Hotelling was an economist in the 1930’s who wrote on a number of topics, but is known for his work in resource economics, and the eponymous Hotelling Rule. Writing in the Journal of Political Economy in 1931, Hotelling theorized that a rational producer of resources, say oil, would only be inclined to extract and sell that resource if the investment opportunities available with the capital proceeds were greater than simply leaving that resource to appreciate in the ground. Sounds reasonable, yes? But it’s not clear that the world–at least in the case of oil producers–has operated this way.

What, for example, did Britain exactly do with 30 years of oil revenues from the North Sea? Did Britain reinvest the proceeds in productive assets? What about all the oil that Britain sold before the era of high prices finally arrived? And how about Indonesia, and Nigeria? While these questions are not easily answered, we do know that alot of the world’s oil was indeed sold too cheaply. And that is why Brazil, with its sea change in resources policy announced this month, is signalling that a new era of oil production is underway.

Why should an owner of oil produce and sell that precious resource as quickly, and as efficiently as possible–to a foreign buyer? To merely fulfill a theorist’s model of maximum efficiency? It will surely be amusing to watch many observers try to rinse this policy through the outdated filters of capitalism, socialism, or nationalism. On the contrary, scarcity rent is in its own separate class.

Brazil’s discovery of new reserves was “a passport to the future,” if handled properly, he (Lula) said. “We don’t have the right to take the money we’re going to get with this oil and waste it,” he said in his weekly radio address. “What we want… is to use this oil to make Brazil a wealthier country, to make it more developed.”

I’m sure some will claim this move by Lula is nothing more than an ill-fated attempt at resource nationalism. Or, others will warn that Brazil doesn’t have the capital required to efficiently develop the offshore reserves, and the result will be a slower extraction of the oil. Well frankly, I think that’s partially the point. After all, Brazil is not dysfunctional like Nigeria, or Venezuela. This is not a destruction of resources through either neglect, or ideology.

In the Spring of this year, a very good panel discussion took place at the Milken Conference in Los Angeles on the topic of oil and oil security (Hahn, Herbert, Lovins, Nyquist). One of the panelists referenced Harold Hotelling, and I think correctly pointed out that his theory “had never fully arrived” among the world’s oil producers. Given the clarity and the stated intention behind this new policy, I’d say Hotelling is now arriving in Brasilia.


Photo: Dois Candangos Monument in Brasilia, by Bruno Giorgi