Intergenerational Resource Rights, Efficiency, and Social Optimality

The discipline of economics is generally defined as the science of the allocation of scarce resources between competing social objectives. Given an initial distribution of resources between economic agents, how would they behave so as to improve their welfare? According to the Pareto criterion, the agents would exchange commodities until the opportunities for fruitful exchange were fully exhausted and no agent could be made better off without rendering at least one other agent worse off. Pareto efficiency is a powerful concept in microeconomic analysis. Provided that the initial distribution of property rights is equitable, allocative efficiency gives rise to the best of all possible worlds. Acknowledging that the assumptions of perfect competition are often violated-firms are monopolistic, information is incomplete, and externalities exist-economists have argued for the modification of institutions so that economic reality will conform more closely to the assumptions of the model that yields such gratifying results. But microeconomic theory has always maintained that allocative efficiency is in itself insufficient to maximize social welfare (Bator 1957). A social welfare function is required to discriminate a social optimum among the array of efficient allocations that correspond to alternative assignments of property rights. Though economists have posited alternative functional forms for the sake of pursuing conceptual arguments, welfare functions have remained elusive constructs for well-known theoretical and practical reasons. Consequently, a sharp line of demarcation has been drawn between questions of efficiency-the province of economics-and equity-the principal focus of ethical and political discourse. In resource economics, however, the line demarcating efficiency and equity is often crossed. The term "optimal depletion" appears regularly where only efficient depletion is meant. While political debates about resource exploitation over time are laden with questions of the proper distribution of our natural patrimony between generations, resource economists have predominantly espoused particular use rules that guarantee efficiency but overlook potential improvements in social welfare achievable through the reassignment of property rights across generations. We document the evolution and current status of the misuse of the term "optimal depletion" in Section II. We develop a simple two-generation, three-period general equilibrium model in Section III to illustrate how alternative distributions of resource rights between generations relate to alternative Pareto efficient solutions. In Section IV we demonstrate how different social welfare functions affect the optimal solution and associated assignment of resource rights between generations.