Environmental Economics

In our Env-Econ 101 series (to the left), we have a lengthy two part explanation (Part 1, Part 2) of the Hotelling rule for depletable natural resources which is basically summarized as:

For a non-renewable, exhaustible resource with completely known stock, no discoveries possible, no alternatives, no recycling, private ownership and constant costs of extraction, the price of the resource will increase at the interest rate over time.

The important corollary to the Hotelling rule regarding transition to alternative fuel sources is:

As the price of the depletable resource rises and/or the price of the alternative resource decreases, incentives are created to switch between the resources.  Once the price of the depletable resources rises far enough, the incentive to continue with extraction diminishes and investments in alternative resources increase.  

On Monday, the Guardian (liberal hacks!) illustrated these results in a succinct attack on Trumpian coal policy titled "The war on coal is over.  Coal lost."  While the article itself is a less than veiled attack on President Trump's environmental policies (I will leave it to others to decide whether such attacks are warranted or not–hint:  they're warranted on economic grounds), a graphic in the article gives a nice illustration of the outcomes of Hotelling's rule:

In the U.S., electricity generation by coal has been surpassed by natural gas for two reasons: 1) Coal has become more expensive in an absolute sense (at least partially due to regulations), and 2) Natural gas has become much cheaper relative to coal (at least partially due to increased use of new extraction technologies like fracking).  Also of note from a Hotelling perspective is the upturn in electricity generation from renewable sources (the yellow-line, at least I think it's yellow, don't trust me on colors, I'm color-blind). 

The Guardian expects the trend to continue:

This trend will continue. As old coal plants continue to retire and be replaced by cheaper renewables and natural gas, their share of the US electricity supply will continue to plummet, and coal will become a fossil fuel in every sense of the word. That’s why American companies continue to invest in cheap, clean renewable energy.

I expect the trend to continue too.  Although my level of certainty changes daily depending on which Twitter policy announcement is to be believed on any given day.  

But if the trend continues, the hard work begins.  Economists are notoriously bad at looking at distributional issues.  But as the mix of energy sources changes, the distributional impacts are likely to be significant on regions dependent on outdated technologies and old energy sources.  The Guardian article puts it this way.

The shift away from coal poses a challenge for regions in which the local economy depends on the fossil fuel, but the transition is inevitable.

Ohio State Professors Mike Betz (Consumer Sciences) and Mark Partridge (Ag, Env, and Development Economics) recently summarized the problem similarly:

Communities that have historically relied on coal production, especially in Appalachia, have been suffering major economic and employment losses for decades. Today far fewer miners are needed to produce the coal that we consume, and alternative energy sources like natural gas, solar and wind have chipped away at coal’s cost advantage. Job losses in coal-reliant regions will only intensify as mining becomes more efficient and the nation takes steps to reduce greenhouse gas emissions.

So what then should these communities do?  Betz and Partridge argue there are two options (in my words) 1) Prop up coal dependent communities by subsidizing the coal industry.  However, as Betz and Partridge lay out, such a strategy is likely to result in investments in labor-reducing, efficiency enhancing technologies, and ultimately reduce the labor-force in these regions.  Seems counter-productive to me. 

Option 2) is to invest in 'people and place.'  Here's how Betz and Partridge make the case:

To spur economic development in lagging regions, it is helpful to consider what types of communities are likely to prosper in the future. Today we can predict that successful communities in 2040 or 2050 are likely be entrepreneurial and have well-educated workforces and high-quality schools.

Educated, highly skilled workers can live anywhere. To attract them, lagging regions need to offer a high quality of life and a clean environment. The Trump administration is moving in the opposite direction by weakening environmental regulation of the coal industry, which will make it harder for coal country to prosper in the long run.

We have found that entrepreneurship and creativity are key factors for promoting economic development in lagging areas of Appalachia. To foster them, aid programs should focus on improving quality of life and attracting new, highly skilled residents. One way to do so is by investing in natural resource amenities, such as abandoned mine cleanup. However, Trump’s budget request eliminates grants to Appalachian communities for economic development in conjunction with abandoned mine land cleanup.