CHAPTER 1

           THE AMAZING THEORY OF RAW-MATERIAL SCARCITY 

   The Great Toy Shortage

   Forget it, Virginia. Santa won't be leaving a "Star 
Wars"       R2-D2 doll under the tree this year - just 
an I.O.U. promising    you one at some vague time 
between February and June. Don't    count on a Mego 
Micronaut kit for building your own robot    either, or 
a Milky the Marvelous Milking Cow, which drinks    
water when its tail is pumped, moos plaintively and 
squirts a    tiny pailful of cloudy white "milk" from a 
detachable pink    udder....  

   Not since the Grinch stole Christmas has there been 
such an    unseasonable shortage.
 
   Newsweek, December 19, 1977, p. 58


CHAPTER 1 - TABLE OF CONTENTS
The Great Toy Shortage
Between Pig Copper and Dentistry
What Do We Mean by "Scarcity"?
What is the Best Way to Forecast Scarcity and Costs?
Will the Future Break With the Past?
A Challenge to the Doomsdayers to Put Their Money Where Their   
	Mouths Are
Summary
Afternote 1
	The "True" Cost (Price) of Natural Resources
Afternote 2: The Ultimate Shortage 

   The "Great Toy Shortage" of 1977 clearly was a freak event. We don't worry that a 
scarcity of Hula-Hoops, pencils, dental care, radios, or new musical compositions will 
last. And we don't fear that a larger population will reduce the supply of these 
goods; manufacturers will make more. Yet people do worry about an impending scarcity 
of copper, iron, aluminum, oil, food, and other natural resources. 
   According to a typical pronouncement by Paul Ehrlich, the best-known contemporary 
doomster, "In the early 1970s, the leading edge of the age of scarcity arrived. With 
it came a clearer look at the future, revealing more of the nature of the dark age to 
come". That we are entering an age of scarcity in which our finite natural resources 
are running out, that our environment is becoming more polluted, and that population 
growth threatens our civilization and our very lives - such  propositions are 
continually repeated with no more evidence than that "everyone knows" they are true. 
   Is there a fundamental economic difference between extractive natural resources and 
Hula-Hoops or dental care?  Why do people expect that the supply of wheat will decline 
but the supplies of toys and drugs will increase? These are the questions that this 
chapter explores. The chapter draws examples from the metallic raw materials, which 
are relatively unencumbered by government regulations or international cartels and 
which are neither "burned up" like oil nor grown anew like agricultural products. 
Energy, food, and land will be given special treatment in later chapters.


                BETWEEN PIG COPPER AND DENTISTRY

   There is an intuitive difference between how we get Hula-Hoops and copper. Copper 
comes from the earth, whereas a Hula-Hoop does not seem to be a "natural" resource. 
Copper miners go after the richest, most accessible lodes first. Therefore, they dig 
into lodes bearing successively lower grades of ore. If all else were equal, this 
trend would imply that the cost of extracting copper from the ground must continually 
rise as poorer and less accessible lodes are mined. 
   Hula-Hoops and dental care and radios seem different from copper because most of 
the cost of a radio, a Hula-Hoop, or dental care arises from human labor and skill, 
and only a small part arises from the raw material - the petroleum in the plastic hoop 
or the silver in the tooth filling. For good reason we do not worry that human labor 
and skill comes from progressively less accessible reservoirs.
   But all this neat theorizing about the increasing scarcity of minerals contradicts 
a most peculiar fact: Over the course of history, up to this very moment, copper and 
other minerals have been getting less scarce, rather than more scarce as the depletion 
theory implies they should. In this respect copper follows the same historical trend 
as radios, undershirts, and other consumer goods (figures 1-1a and 1-1b). It is this 
fact that forces us to go beyond the simple theory and to think more deeply about the 
matter.
   FIGURE 1-1a.  The Scarcity of Copper as Measured by Its Price    Relative to Wages

   FIGURE 1-1b.  The Scarcity of Copper as Measured by Its Price    Relative to the 
Consumer Price Index

   At the end of this confrontation between theory and fact, we shall be compelled to 
reject the simple Malthusian depletion theory, and to offer a new theory. The revised 
theory will suggest that natural resources are not finite in any meaningful economic 
sense, mind-boggling though this assertion may be. That is, there is no solid reason 
to believe that there will ever be a greater scarcity of these extractive resources in 
the long-run future than now. Rather, we can confidently expect copper and other 
minerals to get progressively less scarce.

                 WHAT DO WE MEAN BY "SCARCITY"?

   Here we must pause for an unexciting but crucial issue, the definition of 
"scarcity." Ask yourself: If copper - or oil or any other good - were much scarcer 
today than it actually is, what would be the evidence of this scarcity? That is, what 
are the signs - the criteria - of a raw material being in short supply?

   Upon reflection perhaps you will not expect a complete absence of the material as a 
sign of scarcity. We will not reach up to the shelf and suddenly find that it is 
completely bare. The scarcity of any raw material would only gradually increase. Long 
before the shelf would be bare, individuals and firms - the latter operating purely 
out of the self-interested drive to make profits - would be stockpiling supplies for 
future resale so that the shelf would never be completely bare. Of course the price of 
the hoarded material would be high, but there still would be some quantities to be 
found at some price, just as there always has been some small amount of food for sale 
even in the midst of the very worst famines.
   The preceding observation points to a key sign of what we generally mean by 
increasing scarcity: a price that has persistently risen. More generally, cost and 
price - whatever we mean by "price," and shortly we shall see that that term is often 
subject to question - will be our basic measures of scarcity.
   In some situations, though, prices can mislead us.  Governments may prevent the 
price of a scarce material from rising high enough to "clear the market" - that is, to 
discourage enough buyers so that supply and demand come to be equal, as they 
ultimately will be in a free market. If so, there may be waiting lines or rationing, 
and these may also be taken as signs of scarcity. But though lines and rationing may 
be fair ways of allocating materials in the short run, in the longer run they are so 
wasteful that every sort of society tends to avoid them by letting the price rise 
enough to clear the market. 
   So increased scarcity of a raw material implies a higher price. But the converse 
need not be true; the price may rise even without a "true" increase in scarcity. For 
example, a strong cartel may successfully raise prices for awhile, as OPEC did with 
oil in 1973 even though the cost of producing oil remained unchanged. This suggests 
that, in addition to the price in the market, we should sometimes consider production 
costs as an index of scarcity.
   There are yet other reasons why price does not tell the full story about scarcity 
and our welfare. A product may be readily available, as measured by its price being 
low, and yet there may still be a problem. For example, a daily ration of vitamin X 
may be very cheap, but if people are not getting enough of it there is a problem. On 
the other hand, caviar may be unusually high-priced and scarce this year, but few 
would consider that to be a problem for society. Similarly, the price of a staple food 
such as grain may be higher than in a previous year, but this may not indicate a 
problem - if, for example, the price rises because of an increase in income and a 
resulting increase in the amount of grain fed to animals to produce meat. So, though 
the price of food and social welfare are often connected, they are not identical.
   A more personal - but often relevant - test of scarcity is whether you and I and 
others feel that we can afford to buy the material. That is, the relationship between 
price and income may matter. If the price of food stays the same but income falls 
sharply, then we feel that food is more scarce. By a similar test, if our wages rise 
while the price of oil remains constant, our fuller pockets lead us to feel that oil 
is getting less scarce.

   A related test of scarcity is the importance of the material in your budget. You 
are not likely to say that salt has gotten appreciably more scarce even if its price 
doubles, because it accounts for an insignificant share of your expenditures.

   So price, together with related measures such as cost of production and share of 
income, is the appropriate operational test of scarcity at any given moment. What 
matters to us as consumers is how much we have to pay to obtain goods that give us 
particular services; from our standpoint, it couldn't matter less how much iron or oil 
there "really" is in the natural "stockpile." Therefore, to understand the economics 
of natural resources, it is crucial to understand that the most appropriate economic 
measure of scarcity is the price of a natural resource compared to some relevant 
benchmark.
   Future scarcity is our interest. Our task, then, is to forecast future prices of 
raw materials.


      WHAT IS THE BEST WAY TO FORECAST SCARCITY AND COSTS?

   There are two quite different general methods for forecasting costs of any kind: 
the economist's method and the technologist's (or engineer's) method. The engineering 
method is commonly used in discussions of raw materials, but I shall argue that the 
conclusions about costs reached with it are usually quite wrong because it is not the 
appropriate method.
   With the technical engineering method, you forecast the status of a natural 
resource as follows: (1) Estimate the presently known physical quantity of the 
resource, such as copper in the earth that's accessible to mining; (2) extrapolate the 
future rate of use from the current use rate; and (3) subtract the successive 
estimates of use in (2) from the physical "inventory" in (1). (Chapter 2 discusses 
technical forecasts in greater detail.)
   In contrast, the economist's approach extrapolates trends of past costs into the 
future. My version of the economist's method is as follows:  (1) Ask:  Is there any 
convincing reason to think that the period for which you are forecasting will be 
different from the past, going back as far as the data will allow?  (2) If there is no 
good reason to reject the past trend as representative of the future as well, ask:  Is 
there a reasonable explanation for the observed trend?  (3) If there is no reason to 
believe that the future will be different than the past, and if you have a solid 
explanation for the trend - or even if you lack a solid theory, but the data are 
overwhelming - project the trend into the future.  
   Given the wide disparity between the engineering and economic approaches, it 
behooves us to consider the conditions under which each is likely to be valid.

   The forecasting situation is analogous to that of a businessperson who wishes to 
estimate costs of some piece of construction or production for the firm. Making sound 
cost estimates is the businessperson's bread and butter, the difference between 
solvency and bankruptcy. The choice between the economic or the engineering method 
depends largely on whether the business has much or little experience with the type of 
project whose costs it wants to assess. Examples of jobs with which the organization 
already has a great deal of experience are (a) a construction firm preparing a bid on 
a small parking lot like many others that the firm has done, and (b) a chain 
franchising operation estimating the cost of adding another hamburger shop. In such 
cases the firm will, as a matter of course, estimate costs directly from its own 
records. In the case of the new hamburger shop, the estimate may simply be the average 
total cost of shops recently built, as already computed by the firm. In the case of 
the parking lot, the construction firm may be able to estimate with good accuracy the 
amounts required of the main components - labor and machine time - and their current 
prices.
   It is only when the firm does not have direct experience with the type of project 
being costed that it must and will make an engineering analysis of the project, 
together with estimates of the requirements for each element of the job. But the 
businessperson, and the academic analyst of natural resources, too, should turn to 
engineering cost-estimates only in the unfortunate absence of reliable data from the 
past, because engineering estimates are much harder to make accurately, for a variety 
of reasons. An analogy may help. In forecasting the speed of a three-year-old race 
horse, would you rely more on a veterinary and anatomical inspection of the horse's 
bones and organs, or on the results of its past races?  
   Mercury is an example of how one can go wrong with a nonhistorical, engineering 
forecast. Figure 1-2 shows a forecast made in 1976 by natural-scientist Earl Cook. He 
combined a then-recent upturn in prices with the notion that there is a finite amount 
of mercury on the earth's surface, plus the mathematical charm of plotting a second-
degree polynomial with the computer.  Figures 1-3a and 1-3b show how the forecast was 
almost immediately falsified, and price continued its long-run decline.  (Figure 1-3 
also shows that reserves of mercury have increased rather than decreased over the 
years, just the opposite of naive "finitist" ideas).
   FIGURE 1-2[1-x from Cook], Figures 1-3a and 1-3b [1-y from    Gunther]   
   Fortunately, we don't have to rely on such arbitrary guesswork. Considerable data 
showing trends in raw-material prices for a century or two, or longer, are available, 
as seen in various chapters and the Appendix to this book.  Costs of extractive 
materials clearly have fallen over the course of recorded price history. The 
economist's first-approximation forecast is that these trends toward less scarcity 
should continue into the foreseeable future unless there is some reason to believe 
that conditions have changed - that is, unless there is something wrong with the data 
as a basis for extrapolation.
   In brief, the economist's and businessperson's approach to price trends is to learn 
by experience - relevant experience. As P. T. Bauer put it, "it is only the past that 
gives us any insight into the laws of motion of human society and hence enables us to 
predict the future".

              WILL THE FUTURE BREAK WITH THE PAST?

   Some people believe that we are now at a long-run turning point, and the past is 
not a guide to the future.  Therefore we ask:  How should one judge whether a 
historical trend is a sound basis for a forecast? Specifically, how can we judge 
whether the data from the many decades in the past showing declines in raw-material 
costs are a good basis for prediction?  
   This question is a problem in scientific generalization. A sound principle is that 
you should generalize from your data if you can reasonably regard them as a fair 
sample of the universe about which you wish to draw conclusions.  But prediction is a 
special type of generalization, a generalization from past to future. Prediction is 
always a leap of faith; there is no scientific guarantee that the sun will come up 
tomorrow. The correctness of an assumption that what happened in the past will 
similarly happen in the future rests on your wise judgment and knowledge of your 
subject matter. 

   A prediction based on past data is sound if it is sensible to assume that the past 
and the future belong to the same statistical universe, that is, if you can expect 
conditions that held in the past to remain the same in the future. Therefore, we must 
ask: Have conditions changed in recent years in such manner that the data on natural 
resources generated over the many past decades are no longer relevant?
   The most important elements in raw-material price trends have been (1) the rate of 
movement from richer to poorer ores and mining locations - that is, the phenomenon of 
"exhaustion", and (2) the continued development of technology, which has more than 
made up for exhaustion. 
   Is the rate of development of such new technology slowing up?   To the contrary: 
the pace of development of new technology seems to be increasing. Hence if the past 
differs from the future, the bias is likely to be in the direction of understating the 
rate at which technology will develop, and therefore underestimating the rate at which 
costs will fall.
   The fall in the costs of natural resources, decade after decade and century after 
century, should shake us free from the idea that scarcity must increase sometime. And 
please notice that current prices do not mislead us about future scarcities. If there 
is reason to judge that the cost of obtaining a certain resource in the future will be 
much greater than it is now, speculators will hoard that material to obtain the higher 
future price, thereby raising the present price. So current price is our best measure 
of both current and future scarcity (more about this later).
   Figure 1-1(a and b) and others in the Appendix show the fundamental economic facts 
about natural resources.  The costs and prices of most natural resources have been 
going down rather than up since at least 1800.  But as noted earlier, cost and price 
can be slippery ideas and therefore require technical discussion in an afternote to 
this chapter. Here I'll say but a few words on the matter.
   The basic measure of the cost of, say, copper, is the ratio between the price of 
copper and the price of another product. One such measure - the most important measure 
- of the terms of trade is the price of copper relative to wages, as shown in figure 
1-1a. This price has declined very sharply.  This means that an hour's work in the 
U.S. has purchased increasingly more copper from 1800 to the present. The same trend 
has almost surely held throughout history for copper, and other raw materials.
   Consider a very different measure of cost: the decreasing price of copper relative 
to nonextractive products. This means that it now takes smaller quantities of haircuts 
or underwear to buy a ton of copper than it did a century ago.  The relative price 
between copper and other products is like a price that has been adjusted for the cost 
of living. We must remember that these other, nonextractive items also have been 
produced progressively more cheaply over the years. Yet minerals have declined in 
price even faster than have the other products. 
   Still another way to think about the cost of natural resources is the proportion of 
our total income we must pay to get them. This measure also reveals a steady decline 
in cost. The absolute physical quantities of natural resources extracted have been 
rising, decade after decade, century after century, and the kinds of resources used 
have been increasing in number. But our expenditure on them has been falling as a 
proportion of total expenditures. "The gross value of extractive output [including 
agriculture, oil, and coal] relative to value of national product has declined 
substantially and steadily from 1870 to the present. In 1890, the extractive share was 
nearly 50 percent. By the turn of the century, it had fallen to 32 percent, and, by 
1919, to 23 percent. In 1957, the figure was 13 percent and still trending downward"; 
by 1988 the figure had fallen all the way to 3.7 percent. In 1988, minerals plus 
energy (but excluding food) accounted for only 1.6 percent of the U.S. GNP,  and 
minerals alone (excluding energy sources) accounted for less than half a percent of 
total extractive value, or only about an amazing .0002 (a fiftieth of a percent of 
GNP.  This trend makes it clear that the cost of minerals - even if it becomes 
considerably higher, which we have no reason to expect - is almost irrelevant to our 
standard of living, and hence an increased scarcity of minerals is not a large danger 
to our peacetime standard of living.
   A vivid illustration of the changing role of natural resources is a floppy computer 
disk:  with a standard word processing program on it, it sells for $450.  It embodies 
only a cent's worth of petroleum and sand. 
   This is the closest-to-home indicator of changing raw-materials costs. Every 
measure leads us to the same conclusion, but these calculations of expenditures for 
raw materials as a proportion of total family budgets make the point most strongly.   
Raw materials have been getting increasingly available - less scarce - relative to the 
most important element of life, human work time. 
   Another piece of evidence confirms the price data.  Figure 1-4 shows the total 
world "known reserves" of copper, and the ratio of reserves to total production.  The 
figures show that reserves not only do not go down, they even go up - just as the 
"reserves" in your pantry go up when you are expecting company.  The explanation for 
this anti-commonsensical trend may be found in chapter 2.
Figure 1-4.  Total Copper Reserves, and as a Ratio to Consumption   
   Taken together, the various data suggest the anti-intuitive conclusion that, even 
as we use coal and oil and iron and other natural resources, they are becoming less 
scarce. Yet this is indeed the appropriate economic way of viewing the situation. (To 
explore further these measures of price and scarcity, see Afternote 1 to this 
chapter.)
   In lectures on the foregoing section I commonly ask the audience to raise their 
hands to indicate whether they think natural resources have been getting more or less 
scarce.  Then I show the price data. One woman responded that I had "tricked" the 
audience by drawing their attention away from the physical aspects of depletion.  But 
it is the inappropriate concepts of physical science that have "tricked" this woman 
and many of the prominent doomsters. Like Cook predicting a scarcity of mercury, they 
are led into error by the seductive but unsound theory of "natural" physical limits 
that draws their attention away from the experience of falling raw-material prices 
throughout history.

       A CHALLENGE TO THE DOOMSDAYERS TO PUT THEIR MONEY  
                     WHERE THEIR MOUTHS ARE

   Some respond that these price data are "old" and do not reflect what happened last 
year or last week, and that the long-term trends no longer hold. There is no way of 
conclusively proving them wrong. But the long, sad history of alarming analyses that 
run against previous long-term trends shows the alarms to be wrong far more often than 
simple extrapolations of the long-term trends. 
   Forgive me for sounding strident, but talk is cheap, especially scare talk that 
gets newspaper attention and foundation grants. Where I come from, when we feel that 
someone is talking without taking responsibility for the results, we say, "Put your 
money where your mouth is." I am prepared to back my judgment with my own cash. If I 
am wrong about the future of natural resources, you can make money at my expense.
   If mineral resources such as copper will be more scarce in the future - that is, if 
the real price will rise - you can make money by buying the minerals now and selling 
them later at the higher prices. This is exactly what is done by speculators who 
believe that the prices of commodities will rise (although for convenience' sake, they 
really buy contracts for the commodities, or "futures," rather than physical stocks). 
   Please notice that you do not have to wait ten or twenty years to realize a profit, 
even if the expected changes in supply and demand will not occur for ten or twenty 
years. As soon as information about an impending scarcity becomes known and accepted, 
people begin buying the commodity; they bid up the present market price until it 
reflects the expected future scarcity. Current market prices thus reflect the best 
guesses of professionals who spend their lives studying commodities, and who stake 
their wealth and incomes on being right about the future.

   A cautionary example is how Japan let itself be panicked by fears of future 
scarcities in the wake of the OPEC oil embargo and the resulting general price rise in 
1973. 

     The Japanese, and above all Japanese officialdom, were      seized by hysteria in 
1974 when raw materials shortages      were cropping up everywhere. They bought and 
bought and      bought [copper, iron ore, pulp, sulfur, and coking coal].  Now they 
are frantically trying to get out of commitments to take delivery, and have slashed 
raw materials imports nearly in half. Even so, industrial inventories are bulging with 
high-priced raw materials. 

Japan began paying heavily for this blunder.
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