Sustainability in small open economies under uncertainty

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