Milton Friedman on Mineral Resource Theory (remembering a giant of social thought)

Friedman had not met Bradley but was in the habit of actively communicating with scholars until his final illness. This post is revised from an earlier version dated July 30, 2010, which drew 24 comments.

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I had heard that the great economist and social thinker Milton Friedman (1912–2006) was a prolific communicator with those who posed worthy questions to him. So when I got interested in mineral resource theory, which would culminate with my 2007 essay, Resourceship: An Austrian Theory of Mineral Resources, I asked Dr. Friedman in August 2003 about his views on the late Julian Simon (1932–98), specifically whether Simon’s work on resources, and his conception of the ultimate resource, merited a Nobel Prize in economics. (The answer was yes.)

The discussion continued from there as I tried to flesh out his views of whether “depletable” minerals such as oil were somehow different from “nondepletable” resources, Hotelling-like.

I believe Friedman agreed with Simon that there is no difference from a social science/business perspective. But Friedman disagreed with Simon’s assessment of the contribution of Harold Hotelling, who mathematically proved that the cost and thus price of a fixed resource in a world of perfect knowledge was ‘good’ economics. Read on….

FRIEDMAN TO BRADLEY, 9-4-03
—– Original Message —–
From: “Milton Friedman”
To: “Rob Bradley”
Sent: Thursday, September 04, 2003 10:59 AM
Subject: Re: Questions for Milton Friedman

Dear Rob Bradley:

1. I doubt very much that Julian Simon would have been considered for a Nobel Prize in Economics if he had lived longer.

2. I think he probably should have been considered for a Nobel Prize.  He took a very independent position with little backing, dug deep and provided very good evidence for his predictions and expectations.

Sincerely yours,
Milton Friedman

BRADLEY TO FRIEDMAN, 9-6-03
Dear Dr. Friedman:

As a follow-up question relating to the below, I would like to better understand your view of natural resources and whether you think there is a separate economics of natural resources compared to general economic theory.

But first some background.

I have just completed writing a history of natural resource thought.  I summarize depletionism by looking at W.S. Jevons’ The Coal Question, Harold Hotelling, and other theories such as the bell curve of M. King Hubbert (a geologist) showing the life cycle of fossil fuel production.  Much of this is known at least peripherally by economists.

More originally, I also traced expansionism–a school of resource thought that has not been appreciated or formalized as such.  My “breakthrough” was discovering the writings of an institutional economist who was at North Carolina and then the University of Texas, Erich Zimmermann.  In his 1933 treatise, World Resources and Industry, he offered a “functional theory” of resources that argued that resource exist in the mind, not the ground.  That resources are dynamic concepts and come from subjective appraisals and changing technologies.  Instead of resources as a noun, think of the verb “resourcing” (my word, not his).  Zimmermann, anticipating Julian Simon by many decades, made the point that the greatest resource is the human mind–human ingenuity.

Thus Zimmermann (theoretically–see below) breaks out of the depletionist trap since resources are not seen as a blob.  If you think of resources as a fixed supply, you are caught in the depletionist trap.

Methodologically, his breakthrough is employing subjectivism rather than objective (fixed or given quantity) analysis–giving credence to a point Hayek once made that major advances in economics have come from new applications of subjectivism.

Thus Zimmermann to me deserves his place in the history of economic thought (very few know about him).  But his problem was going on to worry about overproduction and depletion in later chapters of his book, not understanding discount rates and capital values and that sort of thing.  So Zimmermann began a new paradigm of thought–expansionism–for others (Morry Adelman, Julian Simon, etc.) to independently advance.  I now am grappling with how to “close the loop” on this alternative view of the natural resource world.

Now to my questions.

Back around 1978 you wrote an essay, “The Energy Crisis: A Humane Solution” where you questioned the distinction between “renewable” and “nonrenewable” resources since oil, gas, and coal are “producible … at more or less constant or indeed declining cost because of the improvements in the technology of drilling and exploring and so on.”

This statement, during a time of record high oil and gas prices, was bold. It also predates most of the thinking of Julian Simon.  The person making the point was Morry Adelman of MIT who remained focused on production costs unlike so many Hotelling-inspired economists of the period.

1) How did you come to this view?  Was it because of Adelman, your own reflections given a number of studies that came out from the Paley Commission (1952) and books from Resources for the Future in the 1960s, or both?

2) do you believe there really is a natural resource economics in the sense that “depletable” resources have a fundamental difference from reproducible goods?

3) Do you believe, pending more research, that there might be an opposite “paradigm” (from depletionism) of resource expansionism where, indeed, natural resource prices on average can rise less than the rate of inflation because of the cascading effect of new knowledge and technology and expanding capital for mining?  There is a lot of evidence right now that resource prices from the 19th century to the present have increased less than the general basket of goods, but I am wondering if there is something systemic that can be theoretically anchored in the “nondepletable” and indeed expanding nature of knowledge and capital (in capitalistic settings).

4) Regarding #3, I wonder if there should be a prominent place in the economics Hall of Fame for Zimmermann, Adelman, Simon, and maybe a few others for helping to solve one of the riddles of economics, why “depletable” resources do not deplete, and maybe why “depletable” resources expand–or at least can expand over great periods of time.

I have a presentation at the annual Southern Economic Association meeting in November where I will outline these two “natural resource paradigms” in a history of thought speech, and everyone would be most interested in hearing your thoughts, your time permitting.

Best wishes, and many thanks, Rob Bradley

P.S. I have attached a PowerPoint illustrations of two heuristics–one of the “depletionist” bell curve and “expansionist” resource pyramid as a very simple way to contrast the two schools of thought.  Have you ever seen this heuristic?  Is it useful?

FRIEDMAN TO BRADLEY, 9-8-03
Dear Mr. Bradley:

The basic point I believe in your natural resource discussion is that the economic product in question is not coal or oil or natural gas but energy.

The question is, what is the supply curve of energy? The use of coal or oil is a simply a means of producing energy. The stock of coal, of oil, etc., is certainly in some sense finite, but that doesn’t mean that the potential amount of energy capable of being produced by whatever source is to be considered finite.

Energy will be produced in whatever way is cheapest at the time and as new means of producing energy are discovered the particular mode of producing energy will change from coal to oil to natural gas to atomic sources. That is the view expressed in the statement of mine that you quote.

In answer to your questions about that statement, I have absolutely no idea what led me to think of it except that it is straightforward simple economic analysis.

Re your second question, I do not believe there is a natural resource economics.  I believe there is good economics and bad economics.

Three, I do not believe what is involved is an obvious “paradigm.” The question is a factual one whether the long-run supply curve of energy (or other natural resource output), whether it is upward or downward sloping, is trending down.

I have not seen before the heuristics you attached. I do not find it particularly instructive.

Wish you luck at the November meeting.

Sincerely yours, Milton Friedman

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BRADLEY TO FRIEDMAN, 10-5-04
Dear Dr. Friedman:

….  On a related matter, I must ask another favor and draw your attention to an important history-of-economic-thought matter.  It concerns the “mineral resource problem” (depletion) that has given rise to so much pessimism and alarmism.

Here is a simple four page article I wrote

http://www.energyrealism.org/running_out_oil.pdf

where I present a different way of viewing mineral resources.  I champion an institutional economist who was part of the University of Texas institutional school, Erich Zimmermann, who offers a different view of viewing resources from the Harold Hotelling “fixity” view and the “bell curve” of oil production of the late M. King Hubbert.

Two questions:

1) is the “functional theory of resources” (Zimmermann) a sound way to view the “mineral resource problem” (aka depletion) in your view.  Restated, is it “good economics”?

2) F.A. Hayek once remarked that major advances in economics have come from new applications of subjectivism.  I see the above as a challenge to the seductive objectivist, fixity view of minerals, whereupon each extraction reduces supply for the future.  Do you agree with Hayek’s methodological insight in general or in this instance in particular?

Your opinion will be important to share with other economists, and with your permission I will do so.  I feel there is some work to do in this area, even if it is just using the history of thought to get to a sounder base of thinking to address what is, once again, a major public policy issue.

Thank you so much, Rob Bradley

FRIEDMAN TO BRADLEY, 10-11-04
Dear Rob:

Mr. Zimmerman’s views are perfectly sensible  but I do not see in Mr. Zimmerman’s view an application of subjectivism. Indeed it is an implication of the Harold Hotelling analysis. On the Hotelling analysis a resource that is finite will exhibit increasing relative prices over time. In fact, oil has not done so; its price has been falling.  Hence, the Hotelling analysis implies that oil is not from an economic point of view a finite resource, that it is a producible commodity like most others which has an elastic supply curve, more elastic in the long run than in the short run. This point has been understood for a very long time.

This is good economics. I cannot see that it justifies a new category such as a “functional theory.”

I guess I do not agree with Hayek’s insight. I believe that most advances in economic theory come from attempting to explain phenomena which either were not important before or were not recognized as important before rather than from applications of subjectivism. Indeed, in this case, I do not see that subjectivism plays any special role in the correct analysis of the supply and price of oil. I have long argued that there is good economics and bad economics and that that distinction is basic much more so than distinctions between Austrian economics, classical economics, Chicago economics, etc., and I would add functional economics.

Sincerely yours, Milton Friedman

BRADLEY TO FRIEDMAN, 10-14-04
Dear Dr. Friedman:

The categories “good” and “bad” economics may not go far enough in my view.

I propose to take an additional step to delineate between technically correct (and worthwhile) economics and economics that is superior for real-world understanding and policymaking.  There is a lot of economics that is technically correct but misleading, even diversionary.  Such economics must be handled with great care, particularly with students and policymakers who need to get the big picture.

I believe that at least in an Economics 101 sense, “good economics” as you define it can be at odds.  Here is my example returning to Zimmermann versus Hotelling.

Harold Hotelling in his 1931 article complained that standard economic theory was “plainly inadequate for an industry in which the indefinite maintenance of a steady rate of production is a physical impossibility, and which is therefore bound to decline.”  He did not qualify this statement elsewhere in the article and even brought in the real world relevance of his demonstration.

Hotelling was wed to the fixity notion of resources, and not surprisingly, a whole literature developed in the 1970s looking for the depletion signal.

The collateral damage went further.  Some economists at Resources for the Future, previously a bastion of expansive-resource thought, fell into the depletionist trap of predicting that oil and gas prices had to rise.  And you know what James Schlesinger and others in government were saying.  This came out of the seductive demonstration of Hotelling in part, maybe large part.

Zimmermann’s “good economics”–which would have interpreted the 1970s price behavior in institutional terms–was completely lost in the debate, although M. A. Adelman and others brought in some of his ideas through the back door.

Thus as we return to a 1970s-type mentality, I am trying to resurrect Zimmermann’s approach as “better economics” to Hotelling’s “good economics.”

I am trying to get the profession to not look for a “depletion signal” and focus on property rights and other institutional factors to explain the change in petroleum scarcity.

I believe that you see the approaches of Hotelling and Zimmermann both as good economics.  Forgetting labels such as Zimmermann’s “functional theory” and Hotelling’s “fixity theory,” would you go so far as to say that Zimmermann’s approach is “superior” economics to Hotelling’s “good economics.”  Perhaps there are two answers: one as a theoretical economist and one as a historian of economic thought.

My answer is the same: I see better theory as real-world oriented and then can look back to see examples like the above (and like Schumpeter’s attack on equilibrium competition theory) as bad in practice as far as education and policymaking go.

Perhaps from the above there could be three rather than two categories: bad economics, correct economics, and good economics.

I appreciate this exchange and believe it will be a contribution to the history of economic thought.

Sincerely, Rob Bradley Jr.

FRIEDMAN TO BRADLEY, 10-15-04
Dear Rob:

If you use a tool that is designed well for one purpose for a purpose for which it is not suited, that does not detract from the goodness of the tool for its purpose. The same thing goes with economics.  Hotelling’s analysis is good economics. If it is applied properly to the case of oil it produces the right result, namely that oil is not as an economic matter an exhaustible resource. That result follows from the Hotelling demonstration that an exhaustible resource will have a price that is rising over time.

Since the price of oil was not declining over time, it is not economically an exhaustible resource.

Zimmerman’s using Hotelling properly and drawing the right conclusion rather than the wrong conclusion is good economics and to be applauded, but it is not a different kind of economics and it does not mean that his economics is superior to Hotelling’s economics.

I must confess that I tend to stay away from this kind of methodenstriet. I have always said that I would prefer to do economics to talking about how economics should be done or was done or is done.

As a matter of full disclosure, I should note that Harold Hotelling was my teacher. I took both mathematical statistics and mathematical economics from him. He was a great teacher and had a good deal of influence on me. I have no doubt that if he himself had applied his study of exhaustible resources and looked at the data, he would have come to the right conclusion from it.

Sincerely yours,

Milton Friedman
Senior Research Fellow, Hoover Institution,  434 Galvez Mall  Stanford, CA 94305-6010

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A Look Back

What can I say about the opportunity to exchange such as scholar? And note the depth of his knowledge at such an advanced age. Milton Friedman died with his spurs on, as they say in Texas.

Friedman helped me in another way by endorsing a primer written by Richard Fulmer and myself, Energy: The Master Resource (Kendall-Hunt, 2004). He provided a quotation that was too late for the printed copy, but in the brochure we had his following words:

This splendid book effectively debunks the widespread predictions of energy doom. Its factual base is comprehensive, its exposition clear and straightforward, and its economic reasoning sound.

I think of these words on my rainy days. My, what a great scholar wrote them. And what a scholar I aspire to be having received them.

Long live Milton Friedman who would be 98 this July 31!