Since about 2001, several sectors of the economy have become increasingly inefficient, in the sense that it takes more resources to produce a given output, such as 1000 barrels of oil. I believe that this growing inefficiency explains both slowing world economic growth and the sharp recent drop in prices of many commodities, including oil.
The mechanism at work is what I would call the crowding out effect. As more resources are required for the increasingly inefficient sectors of the economy, fewer resources are available to the rest of the economy. As a result, wages stagnate or decline. Central banks find it necessary lower interest rates, to keep the economy going.
Unfortunately, with stagnant or lower wages, consumers find that goods from the increasingly inefficiently sectors are increasingly unaffordable, especially if prices rise to cover the resource requirements of these inefficient sectors. For most periods in the past, commodities prices have stayed close to the cost of production (at least for the “marginal producer”). What we seem to be seeing recently is a drop in price to what consumers can afford for some of these increasingly unaffordable sectors. Unless this situation can be turned around quickly, the whole system risks collapse.
Increasingly Inefficient Sectors of the Economy
We can think of several increasingly inefficient sectors of the economy:
Oil. The problem with oil is that much of the easy (and thus, cheap) to extract oil is gone. There seems to be a great deal of expensive-to-extract oil available. Some of it is deep under the sea, even under salt layers. Some of it is very heavy and needs to be “steamed” out. Some of it requires “fracking.” The extra extraction steps require the use of more human labor and more physical resources (oil and gas, metal pipes, fresh water), but output rises by very little. Liquid extenders to oil, such as biofuels and coal-to-liquid operations, also tend to be heavy resource users, further exacerbating the problem of the rising cost of production for liquid fuels.
I have described the problem behind rising costs as increasing inefficiency of production. The technical name for our problem is diminishing returns. This situation occurs when increased investment offers ever-smaller returns. Diminishing returns tends to occur to some extent whenever resources of any kind are extracted from the ground. If the extent of diminishing returns is small enough, total costs can be kept flat with technological advances. Our problem now is that diminishing returns have grown to such an extent that technological advances are no longer keeping pace. As a result, the cost of producing many types of goods and services is growing faster than wages.