Natural Resource Extraction in a Federation

Abstract

We analyze a natural resource extraction problem in a two-region economy with mobile labour. One of the regions produces only manufacturing goods while the other produces agriculture and extracts a nonrenewable natural resource. The manufacturing sector exhibits increasing returns-to-scale if the level of production is sufficiently high. There are multiple equilibrium allocations of labour towards which the economy may converge in the long-run depending on the initial stock of natural resource and the initial distribution of labour. Under decentralized resource management, there is a tendency to over-extract the resource relative to the constrained federal optimum, which tends to enlarge the set of initial conditions under which the economy converges to the low-income equilibrium. The optimal path of extraction from the perspective of the federation satisfies a modified Hotelling’s rule that takes into account the impact of resource extraction on manufacturing production.