Should We Worry About the Failure of the Hotelling Rule?

The continuing dependence of the global economy on fossil fuels is worrying because it imposes limits on growth due to the non-renewable nature of these resources and also contributes to global climate change. Resource optimists believe that this is no reason to worry, because the economy will always find a way to overcome these constraints. Their arguments, however, require that resource prices reflect the scarcity of non-renewable resources, which implies that they must obey the Hotelling rule . Empirical analyses, however, show that the Hotelling rule does not hold in reality, which raises the question: does the failure of the Hotelling rule imply that social optimality is not achieved? This paper argues that the answer depends on the reason for the failure. If extraction and exploration costs, or technological progress in these activities, are the reasons for the failure, a market failure is not implied, and optimality may still be achieved. But if the Hotelling rule fails due to uncertain property rights or strategic interaction, the market will surely fail to provide an optimal solution. A market failure is likely to speed up resource consumption compared to the social optimum. Copyright © 2008 The Author. Journal compilation © 2008 Blackwell Publishing Ltd.