Sustainability in small open economiesunder uncertainty

Abstract

Sustainability of the average level of consumption in a resource‐rich country is examinedin the presence of uncertainties in terms of trade for the country. In an open economy, weassume that prices are taken as given but may be subject to some fluctuations. Planners inthe resource‐extracting economy have the knowledge of the current resource price at eachmoment in time, but are not sure about its future courses. We examine the validity of therule on a constant consumption path, presented by Hartwick, and show that investing theHotelling rent of current extraction into non‐exhaustible capital markets does not guaranteethe constancy of consumption even in the expected sense. Thus, we need modifications onthe investment rule. To obtain the constancy of consumption, it is shown that gain and/orloss effects from uncertainty should be taken into account in addition to the terms‐of‐tradeeffects examined by previous authors.