Crystal gazing with McKinsey on resources for the future

In 1980, the biologist Paul Ehrlich and business school professor Julian Simon famously wagered on the likelihood of resource scarcity over the coming decade. Based on his expectation that population growth would lead to a rapid growth in demand for basic resources, Ehrlich bet that the prices of five commodity metals would increase; Simon, argued that rising prices incent human innovation and consequently that resource prices should be stable or declining. In the decade that followed, despite population growth of 800 million, the prices of all five commodities chosen by Ehrlich declined and he paid the bet. In July 2011, the investor Jeremy Grantham noted that if the bet had been extended to 2011, Ehrlich would have won – by a lot. 

McKinsey Global Institute, a research arm of McKinsey & Company, recently revisited the debate about economic growth and resource scarcity with the release of a major study, “Resource Revolution: Meeting the world’s energy, materials, food, and water needs”. One of the lead authors, McKinsey partner Jeremy Oppenheim, recently visited the World Bank in Washington DC to describe the report’s conclusions and discuss its implications for development strategy, particularly for the World Bank. His presentation captivated a large audience and provoked a lively discussion.

The key findings of the report can be summarized in two categories – challenges and opportunities. The former starts from the projected increase of up to 3 billion more middle class consumers in the next 20 years, driving up demand at a time when finding and extracting resources is becoming increasingly difficult and expensive, while also resulting in enormous environmental pressures.

The good news is the existence of sufficient technically and economically feasible efficiency improvements and alternative technologies to meet nearly 30 percent of predicted demand and offset much of the projected growth. Some of these measures are already identified and well understood, such as improving the efficiency of buildings and irrigation – a “resource productivity revolution”. These measures would, however, not be sufficient to alleviate poverty and avoid global warming in excess of the two degrees Centrigrade widely considered the threshold.

To meet these goals, McKinsey outlines an additional level of ambition with respect to clean energy and carbon sequestration.

The discussion brought out numerous key issues and assumptions from a development perspective:

• The investment requirements and increased Greenhouse Gas implications associated with poverty alleviation and extension of modern energy services are modest, relative to other global resource challenges. Poverty alleviation and global economic growth are not in conflict.
• Water and land are most likely to present the most severe supply constraints over the next 20 years if the world attempts to meet demand primarily by increasing production. The projected need is set to increase by 140 percent and 250 percent respectively relative to the past two decades.   Pushing on these constraints is likely to cause major environmental pressures including a rise in global average temperatures of more than five degrees Celsius by the end of the century.
• Strategies based on either supply expansion or resource productivity improvement require enormous capital investment -- $3 trillion per year on an average in the former, somewhat more in the latter case – more than a $1 trillion a years above historical expenditure. Moreover, investment would have to be channeled in substantially different ways from historical experience, a source of major institutional and managerial challenges.
• The greatest challenges to improving resource productivity and reducing carbon emissions are mostly not technological or economic – the estimated value associated with the proposed productivity improvements approaches $3 trillion in 2030, before accounting for environmental benefits and subsidies. Appropriate markets signals will be necessary but not sufficient. The majority of opportunities will be difficult or very difficult to capture due to institutional, behavioral, and political barriers – all issues within the Bank’s traditional role supporting good governance, policy reform, and human resources.

As the Ehrlich-Simon wager indicates, making predictions based on past trends and knowledge of current technologies and resource constraints is risky business. On the other hand, McKinsey’s analysis shows that the stakes are rising and we cannot afford to simply look away, rely on markets, and hope for the best. As Paul Ehrlich observed upon losing his bet:  “Julian Simon is like the guy who jumps off the Empire State Building and says how great things are going so far as he passes the 10th floor.  I still think the price of those metals will go up eventually, but that's a minor point. The resource that worries me the most is the declining capacity of our planet to buffer itself against human impacts.”