How High Oil Prices Lead to Recession

There is ample evidence that spikes in oil prices leads to recession, at least in the US, which is an oil-importing nation. James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes. How does this happen? An analogy can perhaps help explain the situation. This analogy also sheds light on a number of related economic mysteries:

  1. How can oil have a far greater impact on the world economy than its share of the world GDP would suggest? After all,  BP’s World Energy Outlook to 2030 shows the world cost of oil is only a little over 4% of world GDP.
  2. How can high oil prices continue to act as a “drag” on the economy, long after the initial spike is past?
  3. Why isn’t a service economy insulated from the problems of high oil prices? After all, its energy use is relatively low.

The Oil Analogy

An oil product, such as jet fuel, is in some ways analogous to a specialized employee, with skills different from what human employees have. Let’s think of an airline. It has human employees–pilots, copilots, flight attendants, baggage workers, mechanics, and airport check-in personnel. None of these human employees can actually provide the energy to make the jet fly, however. It takes jet fuel to do that.

What happens if the price of jet fuel triples? Jet fuel is now more that than triple the price (near $3.00 gallon) it was in the late 1990s (under $1.00 gallon, at today’s prices).

Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.

Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.

The high cost of jet fuel is analogous to the jet fuel employees’ union demanding triple the wages they were paid previously. So what is the airline to do? With very high aviation fuel prices, many tourists who might buy airline tickets will be “priced out” of the market for long distance travel. The airline can sell some airline tickets at higher prices, but not as many.

One thing airlines can do is to cut the number of flights, taking the least fuel-efficient planes out of service and reducing flights on routes with the most unfilled seats. According to a recent Wall Street Journal article, airlines spend 34% of revenue on fuel. With such a high fuel cost, even with these changes, airline ticket prices will remain high. But perhaps with fewer flights, the airline can make a profit.

If an airline cuts its number of flight, this leads to an “across the board” cut in the goods and services the airline buys. The airline will use less jet fuel (and thus use fewer “jet fuel employees”). If it is able to retire quite a few fuel-inefficient jets, “jet fuel employees” will be cut to a greater extent than human employees. It will use fewer human workers, at all levels: pilots, copilots, flight attendants, and ground workers of all types. The airline will reduce its electricity usage because it needs fewer gates in airports for its operations. The airline will also need less gasoline because it will operate fewer baggage-transport vehicles and other ground vehicles.

In many ways, the airline is simply shrinking in size to reflect reduced demand for its high-priced services. When this happens in multiple industries, the result looks very much like recession. I described this situation earlier in a post called How is an oil shortage like a missing cup of flour?. In that post, I said that if oil supplies are short, the situation is not too different from a baker who does not have enough flour to make a full batch of cookies. If he still wants to make cookies, he needs to make a smaller batch, and so needs to cut back on all of the other ingredients as well.

Other Changes an Airline Can Make to Fix Profitability

Apart from cutting back on the number of flights and retiring inefficient jets in the process, there are other things an airline can do to offset the higher “wages” demanded by the jet fuel employees union. One is to reduce the wages of human workers. For example, wages and pension plans of pilots can be cut back, or hours lengthened.  Wages of other workers can be frozen or cut back.

Another approach is a merger with another airline, so that “redundant” employees can be eliminated, and flights can perhaps be cut back further. Of course, these layoffs and cutbacks in wages will add to recessionary impacts, because these workers will have less discretionary income.

A third approach to restoring profitability is to automate some of the functions previously handled by human employees. In this case, electricity is used to substitute for human workers. We can think of this automation as substituting new “electrical employees” (analogous to the “jet fuel employees”) for human employees. Relative to the amount of physical work (pushing buttons, moving luggage, etc.) humans can do, humans are far higher paid than either “oil employees” or “electricity employees”. If we assume that the energy of humans is similar to that used by a 100 watt light bulb, at $20,000 a year, humans are paid roughly 1,500 times as much as “oil employees” and 3,500 times as much as “electricity” employees, to do equivalent physical work. So if automation is an option, it almost always saves money.

A fourth way an airline can reduce costs is by purchasing lighter, more fuel-efficient jets. Making a transition of this type takes a long time. Boeing’s Dreamliner 787 is an attempt in this direction, with a 20% fuel savings anticipated. Boeing has over 800 jets of this type on order, but the 50 already in use have been grounded until battery problems are resolved. Quite a few changes have been made in the new jet, so there is a possibility of additional problems also needing to be ironed out, before production ramps up as planned.

Another Example: Asphalt

Asphalt is another product whose consumption has dropped in recent years.

Figure 2. Trends in US Fuel Consumption by Type, with 1994 = 1.0, based on EIA data.

Figure 2. Trends in US Fuel Consumption by Type, with 1994 = 1.0, based on EIA data.

The amount of asphalt produced in 2012 was only about 70% as much as was produced in 1994. The reason for the shortfall in asphalt is partly because at current high oil prices, refineries can make more profit by selling high-valued products like gasoline, diesel, and jet fuel than they can make by selling asphalt. A recent EIA article titled, Hydrocracking is an important source of diesel and jet fuel, makes the statement, “A refinery’s ability to upgrade low-value products into high-value products and convert high-sulfur material to low-sulfur material with a secondary unit like a hydrocracker plays a key role in determining its economic fate.”

State budgets are tight for a variety of reasons, including inadequate gasoline taxes to cover the cost of maintaining roads. While part of the need for asphalt can be obtained from recycling, many  governments are finding that today’s asphalt costs are so high that concrete roads would be cheaper in the long runMany states have found it necessary to go back to gravel on some of the smaller roads, because of the high cost of paving today. State and local budgets are likely to be stretched even farther if the US government solves its budget woes by sending programs back to the states, and lets the states work out the funding.

What happens when a state decides move some roads from asphalt back to gravel? For one thing,  jobs lost in the road paving business. Also, the new gravel roads have an uneven surface, providing more rolling resistance, so automobile and truck mileage is poorer. In addition, roads tend to degrade more quickly, keeping long-term maintenance costs high. If budgets are tight and roads are not maintained, there is a chance gravel roads will become unusable.

If local governments continue to use asphalt for paving (or switch to concrete, which has even higher initial costs, but lasts longer), they find a need to cut back on other types of services they provide, if they are to avoid a tax increase. This leads to services such as library hours being cut. Cutting back on services reduces both wages and energy costs (lighting and heating/cooling costs). The effect is not all that different from what happens in the airline industry: cuts are made that affect both wages and energy usage of many types. Employee wages seem to be especially affected because changes in employee hours can be made more easily than, say, closing a building or running fewer school buses.

The More General Problem

It is not just airlines and users of asphalt that cut back because of high oil prices. The story plays out in different ways in many industries. Clearly any restaurant is at risk if high oil prices cause consumers to cut back on discretionary purchases, because reducing the frequency of eating out is an easy way of reducing discretionary expenditures. If restaurants have fewer customers, some restaurants will close and are not replaced. This is the restaurant industry’s  way of “making a smaller batch”. The result is fewer jobs, less oil use, and less use of resources in general.

Another type of discretionary purchase that gets cut when oil prices are high is the purchase of a new car. A recent article by the New York Times says that the recovery of auto sales since the recent recession has been very slow, with charts for several countries. Reduced car sales is yet another example of making a “smaller batch.” The result is fewer jobs, less use of oil, and less use of many other types of resources.

A similar story can be told about new home sales. These dropped in the recent recession, and have been slow to recover. The drop-off is frequently attributed to the housing bubble bursting, but rising oil prices played an important role as well. When oil prices increased in the 2004-2005 period, the Federal Reserve raised interest rates, trying to cut oil prices. Instead, the higher interest rates together with lower discretionary income from high oil prices led to lower housing prices, starting in 2006. (See my article from the journal Energy, here or here.)

The Economic Implications of High Oil Prices

Our economy is all about “adding value”. But where does this value added come from? To a significant extent, this value comes from adding external energy of some sort. It is really the “energy employees” I mentioned earlier that add this value. Human workers are needed as well, but with automation, the number of human workers required tends to decline.

The ability of external energy to add value is what causes the link between  GDP, energy consumption, and oil consumption. Oil plays a special role, because it is easily transported, and can be used in many situation where electricity or some other form of energy (such as human energy, wind energy, or natural gas) would not work.

If we look at a graph of changes GDP compared to changes in world oil and energy usage, (Figure 3, below), we see that all three tend to rise and fall together. In fact, changes in oil and energy usage appear to slightly precede GDP changes. This is the pattern we would expect, if economics are causing a “smaller batch” to be made when oil prices are high.

Figure 3. World growth in energy use, oil use, and GDP (three year averages). Oil and energy use based on BP's 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

Figure 3. World growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

Part of this change may simply reflect a transfer of energy use from less efficient industries (ones using more high-priced oil in their fuel mix) to more efficient industries (ones using less high-priced oil in their fuel mix). If could also reflect a shift in oil and energy distribution to more less efficient countries (ones using more high-priced oil in their fuel mix) to more efficient countries (ones using less high-priced oil in their fuel mix). For example, Greece (which specializes in vacation tourism, and which uses much oil in its energy mix) would be expected to be an oil/energy loser (Figure 4, below).

Figure 4. Greece's growth in energy use, oil use, and GDP (three year averages). Oil and energy use based on BP's 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

Figure 4. Greece’s growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

China (which uses much coal in its energy mix and thus keeps costs low, and specializes in inexpensive manufacturing) would be expected to be an oil/energy gainer (Figure 5, below). See my posts, Energy Leveraging: An Explanation for China’s Success and the World’s Unemployment and Why Coal Consumption Keeps Rising, for discussion of this issue.

Figure 5. China's growth in energy use, oil use, and GDP (three year averages). Oil and energy use based on BP's 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

Figure 5. China’s growth in energy use, oil use, and GDP (three-year averages). Oil and energy use based on BP’s 2012 Statistical Review of World Energy. GDP growth based on USDA Economic Research data.

High prices work together with a number of other factors (including increased automation and increased competition from countries with lower wages) to force wages of humans down, and to reduce the number with jobs. The proportion of US citizens with jobs started declining about the year 2000 and accelerated with the recent recession:

Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census.  2012 is partial year estimate.

Figure 6. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

If we look at the ratio of wages (broadly defined, including proprietors’ income and taxes paid on behalf of employees by employers, but not including transfer payments, such as Social Security payments and Unemployment Insurance) to GDP in Figure 7, below,  we see that the ratio of wages to GDP has been dropping since 2000–another indication that human wages are not keeping up with the rest of the economy.

Figure 7. Wage Base (defined as sum of "Wage and Salary Disbursements" plus "Employer Contributions for Social Insurance" plus "Proprietors' Income" from Table 2.1. Personal Income and its Distribution)  as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

Figure 7. Wage Base (defined as the sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

If “Energy Employees” Are Really Doing Most of the Work

If it is really the “energy employees” doing most of the work, then the models used by many economists today are not really correct, and some of the standard beliefs based on these model aren’t right either. For example:

1. The idea that the value of oil or other energy to the economy is proportional to its price doesn’t hold. This can be seen from the examples provided. In fact, if oil or another needed energy product is removed, very close to no work gets done. Humans can provide a little energy, but compared to the energy of oil or electricity, our efforts are puny, and very high-priced. Without external energy, humans’ efforts are limited to tasks like digging with a stick in the ground, or making baskets with reeds that they have gathered.

2. One type of energy doesn’t necessarily substitute easily for another type of energy. Just as one type of employee (mechanic, airline pilot, or flight attendant) can’t necessarily be substituted for another, one type of energy cannot necessarily be substituted for another. Dreamliner’s battery problems illustrate that even trying to substitute a little more electrical energy for oil energy can provide a technological challenge.

3. Somewhat surprisingly, high oil prices remain a drag on the economy permanently, because the high wages of the “oil employees” remain. Output isn’t any higher with these higher wages, so there is not a proportional benefit to society from these higher oil wages. More human workers may be hired in the oil extraction process (often in another country). But even if more workers are hired in the same country, their output does not replace the entirely different kind of output that is provided by the (now-unaffordable to many) high-priced oil.

Another factor in the slow uptake of high oil prices is the fact that governments can temporarily hide some of the effects of high-priced oil through unemployment benefits and stimulus programs. This temporary cover-up cannot continue for long, though, because governments (such as the US and other oil importers) soon run into problems with high deficits (as is happening now). When governments raise taxes or reduce benefits to solve their financial problems, the deferred high-priced oil problems return, showing that the problem never really left.

4. An economy which is mostly services, is not insulated from the problem of high oil prices. Both the airline and asphalt examples illustrate how high oil costs can circulate through the economy and disrupt discretionary spending, even in the US.  (Also see Ten Reasons Why High Oil Prices are a Problem.)

Services tend to be the “fluff” of society because for the most part, because we could live without them, at least temporarily. For now, we have a temporary respite from oil-price impacts because of high deficit spending by governments. If governments are forced to balance their budgets, cutbacks seem likely in many areas of services, including medicine for the elderly, higher education, and government-sponsored research programs. If cutbacks occur in areas such as these, we can expect that GDP will shrink faster than savings in oil and energy use–a reversal of what has happened in the past, and a reversal of what many economists have come to expect in the future.

Also, contrary to popular belief, we cannot increase the economy very much by simply selling services that do not require energy to one another. It really takes “energy employees” to play their role as well. Without external energy, we can dig in each others’ back yards with sticks, but this activity doesn’t add much to the economy. We need “energy employees” playing their role as well, if we are to have computers, and metal scissors, and the many other tools we expect, even in a service economy.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
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85 Responses to How High Oil Prices Lead to Recession

  1. Gary Goddmn says:

    re: Rodger Malcolm Mitchell and monetary solvency.
    It’s absolutely true that Fed Gov as well as other similar monetary systems like Australia, Japan, Canada, England, create money by edict, by writing checks out of Treasury or otherwise issuing payments.

    Congress’ own rules mandate that the Tsy must issue Securities to middleman banks when spending is greater than taxation, and Tsy is FORBIDDEN by Congress from issuing Securities directly to the Fed in exchange for Dollars …. even though that’s what happens eventually to an extent via the Primary Dealers who act as brokers for T-securities for other buyers/investors.

    In other words, Congress created this “kludge” of corp welfare called “national debt” and even though the “need” (?) for this was abolished in 1971 along with the remnant of the Gold Fixed Exchange for FOREX, Congress *chooses* to keep paying this corp welfare. Anyone surprised?

    So it’s true that Congress could tweak some laws, less than what they tweaked to enable Citibank to bypass Glass-Steagall, and then abolish that, and then the Treasury could SPEND without incurring so called “debt”. (Reserves would have to pay interest, otherwise those holders and savers of US Dollars would not earn interest … more austerity, but against big capitalists.)

    ON THE OTHER HAND, resource depletion is a serious issue. Steve Keen says he’s prefer to be working on resource and environment issues, but he’s trained as an economist and so he’s working on that, and would like to see a *sane* not neo-classical economic system and theory replace what we currently struggle with, assuming that Mankind and technology beats the resource crisis.

    From bits I’ve read, the technology exists NOW, at least in prototype, to produce nearly unlimited energy and for vast energy savings vs wasteful tech, but (a) it’s not profitable (b) energy sellers oppose that (c) we think there’s not enough Govt money available to develop that the way canals, railroads, interstates, the Internet, and space travel was developed by Govt.

    • One view of what we run short of first is the capital needed for investment. There is not enough of an energy profit from existing sources, and needed investment keeps growing, so we don’t have the where with all to make the investment in expensive new sources.

      The other thing I have become aware of recently is the extent to which shortfalls get concentrated in the government. We have way too many people without jobs. The government tries to fix this, but just digs itself into a deeper and deeper financial hole.

      WHen you put those two things together, you get a situation in which the government, which has historically funded the big capital investments in the past, is no longer able to do so. This is a big problem. Even if there are theoretically solutions, we can’t follow them through. (I am not sure that there are solutions, though. Even so-called renewable solutions seem to lead to excess heat build up or some other problem.)

      • You said, “The government tries to fix this, but just digs itself into a deeper and deeper financial hole. When you put those two things together, you get a situation in which the government, which has historically funded the big capital investments in the past, is no longer able to do so.”

        An understanding of Monetary Sovereignty would show you that the U.S. federal government cannot have a “financial hole,” and has the unlimited ability to fund capital investments.

        Rodger Malcolm Mitchell

        • GermanStacker says:

          You ignore many things in your narrow theory, among them financial markets, especially currencies, derivatives, the shadow banking system… Today every move of central banks and governments is monitored by millions of investment computers by the millisecond. They are not interested in the fundamental truth, just in the spread. A wrong decision by one central bank, a sudden inflation fear, exploding interest rates = good luck. Yes I know, governments shouldn’t borrow from their central bank, only they do…

        • GermanStacker says:

          RMM – as there is no reply button below: “what part of that is wrong?”
          As you suggested to everyone, I had a look at your blog, so I refer to your general idea which I understand is saying, our situation is “governments should better understand that they are monetarily sovereign, just come up with all the money and invest it wisely”. But as long as governments DO borrow, there ARE bond markets and interest rates and currencies, there ARE special interest groups close to power, it doesn’t matter what governments could or should be doing. First they have to unwind the current system, and I want to see how they are going to do THAT without some form of collapse. So I prefer to focus on the practical aspects, others may like to think about how the system should be later.

      • GermanStacker says:

        About the topics of unemployment, government funding, happiness… I have known young people in Saudi Arabia who don’t have the need to work, because in their country there are few jobs, but government provides almost everything. They “study”, meaning they go shopping and sit around in cafes. In Chile I talked to people who had very well-paid jobs with international companies, but these jobs required no real work, only driving around some miles and check the oil and gas equipment. Then they went home to their big new houses in the middle of nowhere, parking their big SUV’s on the front lawn, watch TV and eat.
        No effort, no scarcity, but in both cases I felt this way of life was kind of unreal, and I was glad to have a job where I am really “doing” something, living in a 700 year old town, a mix of different people with their individual stories and problems…
        It seems to me that to struggle with limited resources, and yes, scarcity, is a very healthy and natural thing. They say we grow most when we meet resistance. Whenever I hear about the concept that cheap energy and the wealth it brought us is an anomaly in human history, this resonates very much with me.
        Also, many people have opinions about the oil & gas industry, but never really went into the details of that business. The shale boom and even the tar sands are just side stories. You have to read the whole history, e.g. what happened in Russia after 1989. It’s just unbelievable. These are modern kings with enormous wealth and power. The investment and exploration decisions of the big international and national oil companies are titanic in risk, time horizon and scale. And they are more concerned with CO2 politics than with “free energy”. But since 1860 they know that the black gold is the life blood of the world, and they know that until 2030 we will probably double the number of IC engine cars in the world once again, they are on the winning side like never before. The vast majority of global public consciousness is oblivious to a renewable-driven world, that’s more like a western phantasy. After decades, you still see no electric cars on the road. BAU is triumphant, with the momentum of 7 billion people in the global village.

        • I think you are right about struggles against resource scarcity being normal, throughout history. We have gone through a period, where at least for some, the struggles have been replaced with more entertainment and less need to really “do anything”. Now, I am afraid we get the rebound.

          Regarding about how the rest of the world thinks about fuels, when I spoke at an energy conference in India in October, I was struck by how focused the speakers from there were on getting more fossil fuel energy to their people, as quickly as possible. They could see that that was the way to lift standards of living. So they were busy talking about replacing traditional fuels for cooking (sticks and dung) with LNG, and how to get more fuel for automobiles.

      • BC says:

        Gail, when you refer to “running short on capital needed for investment”, you refer knowingly, no doubt, to a dearth of (1) necessary rate of change of growth of rentier profits extracted from labor and production by the top 0.1-1% as a result of claims imposed on same from debt-money growth in perpetuity; and (2) the inability of net energy (from any source), physical plant, equipment, production, and wage labor as a share of GDP to grow at a sufficient differential rate to debt-money claims to keep real GDP per capita growing to sustain ultimately growth of demand to permit growth of extraction of increasingly costly fossil fuels.

        IOW, in a closed system, such as the planet Earth, there is a non-linear log limit bound constraint in terms of the differential rate of low-to-high-entropy net energy transfer and resource services throughput per capita with respect to growth of population, consumption per capita, and the implied equilibrium rate of extraction of net energy per capita. IOW, we can’t afford to grow debt-money claims AND extract oil at $100+/bbl, AND increase real GDP and gov’t spending and transfers per capita to sustain the current socially acceptable standard of material consumption and well-being for the bottom 90%+ of households; it is mathematically and thermodynamically impossible;

        However, this is not an acceptable political position to take because it by definition invalidates the legitimacy of the prevailing dubious assumptions of economics, the system of debt-money creation and implied claims, ownership of the means of production and the system of governance, and the purpose, functioning, and means of funding gov’t.

        Therefore, there is currently a very low likelihood of a desirable political solution to Peak Oil, population overshoot, and biophysical/thermodynamic limit bound constraints on the collective desires of the human ape species.

        We effectively want want we cannot possibly have on a finite planet, which suggests that our species is far more childish than wise, and Nature is making a list, checking it twice, and preparing to send us an after-Christmas bill most of us and our progeny cannot afford to pay.

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  3. Ian Schindler says:

    The cost share theorem, the theorem stating that the importance of an
    economic sector to the economy is reflected in it’s cost, or cost share
    would be laughable were it not that so many people take it seriously.

    With respect to oil, the cost share of oil cannot be dissociated with the
    cost share of the capital that transforms the oil into useful work and the
    useful work provided by this capital. By oil’s capital, I refer to cars,
    buses, planes, ships, etc which convert oil into passenger or cargo ton
    kilometers (among other things), the useful work provided by this capital.

    From 1870 to 2002, the price of a barrel of oil (ajusted for inflation) was
    highly volatile around a constant average. A positive feedback cycle characterized
    economic growth. Oil capital pulled oil prices higher stimulating increased
    oil production lowering the price of oil. Lower oil prices stimulated higher
    production of capital: the sales of more cars, boats, planes, etc. Then came
    the ominous two doublings of the price of oil, the first from 2002-2005,
    accompanied by a (roughly) 3% per year increase in production, then another
    doubling of price from 2005-2011 accompanied by a mere 1% annual increase
    in production. The feedback cycle is now turning negative. Price rises have
    caused a decrease in the number of vehicle miles traveled in the US and
    Europe. This is leading to lower than expected oil prices (I speak of those
    investors who were counting on high prices and invested in producing oil
    from expensive sources). This will eventually lead to lower production. When
    production decreases, the existing capital will pull prices higher further
    decreasing demand for new capital transforming oil into useful work. Thus
    decreased oil production will immediately lead to reduced employement in the
    automotive and aerospace industries. Decreased vehicular distance travelled
    will affect many tertiary industries, such as the hotel business,
    agriculture, waste management, etc.

    The negative feedback cycle is setting in. To my mind, the most import economic problem today is how to solve socio-economic problems without economic growth.

    • BC says:

      “The negative feedback cycle is setting in. To my mind, the most import economic problem today is how to solve socio-economic problems without economic growth.”

      Ian, succinctly articulated (unlike my musings). Thanks. A radically new system of resource extraction, production, distribution, income and purchasing power, and gov’t purpose, function, and funding is required to avoid a zombie apocalypse.

      • Ian Schlindler is a professor at the University of Toulouse in France. I am fortunate to have many learned readers of diverse backgrounds, who are willing to share their insights.

      • And to be frank, the willpower for a “radically new system” is simply not here now. It most likely requires a departure from capitalism towards more socialism with a stronger government (that can still be democratic with real equality and NOT based on the will of a rich elite) that can control both the production and consumption. I really cant see this happening in any western countries at least. Perhaps China once they realize that their race to western lifestyles is really the wrong direction.

        Any change in this system is most likely only going to happen whenever there is serious collapses in society, or serious side effects like famine or disease – perhaps a couple of nasty weather incidence to top the cake and hammer in the idea that “humans can affect the ecosystem after all”. I am still very much amazed at how many people still feel that we live “above” the physical world around us as long as you have enough money. A few of us grasp a notion of whats wrong and in what direction the world needs to take, but there is just too few voices now and definitely too few ears listening. Neither are we really able to communicate the necessary steps as they really step on peoples assumptions about what to expect from their lives (most likely seriously reducing their living standards).

        As some has commented here (Don Stewart is especially clear on this), I think the first step is to define “what is enough” for people to live a full and rich life. Atm, the definition is completely out of whack, as people expect to travel to the other side of the planet on holidays once or twice every year, or even commute 500 km work in one city while living in another. That isnt a life, thats slavery to cheap energy! The sooner you can appreciate life without these things, the easier it will be to “pry the toys” from our hands once the cheep abundant energy game is up.

        • BC says:

          Well said, John. Historically, socialism, as we have come to perceive it generally, is dependent upon the net energy and capital surplus from capitalism from which to obtain revenues with which to fund Leviathan’s social programs and wars. With global crude oil extraction, oil exports, and real GDP per capita no longer growing, and debt/GDP constraining growth of gov’t spending per capita, capitalism is no longer producing a surplus per capita sufficient to sustain socialism.

          We now have corporate-statism or state-capitalism in which a growing disproportionate share of returns from (un)economic activity goes to the top 0.1-1% who use their wealth and income to purchase the best gov’t money can buy much in the way they retain the services of attorneys, tax accountants, house staff, private security, etc. Gov’t works for the owners of the corporate-state. The top 0.1-1% have a virtual 100% claim on all future labor, production, profits, and gov’t receipts in perpetuity by virtue of their disproportionate ownership of debt-money assets, controlling share of the Fortune 100-300 firms, and the electoral system via the mass media, campaign financing, and the courts. The system has been wildly successful for the top 0.1-1%; therefore, there is no incentive whatsoever for any “reforms”, let alone a radical transformation of the system of the ownership of the means of production and income distribution.

          Nothing short of a complete overthrow of the hierarchical rentier-oligarchic Power Elite top 0.01-0.1% is required. Few have the understanding of history, human nature, cause-effect, wisdom, courage, or stomach for such a r-evolutionary project. The Power Elite do, and they have been engaging in a Nietzschean “war on the masses” for a very long time. A small minority beyond the ramparts of the Power Elite’s fortresses do possess such qualities, but they are easily discredited by those with the power over the mass-media messaging machine, or they are easily shouted down amidst the din of the restless zombified rabble of whom most of us are becoming.

          • Indeed. But please note that when I talk about socialism I talk about equal rights to resources and an expected input from each person into doing necessary work in the society to keep the wheels running (even if it means only 4 hour work days due to the size of the population). I believe socialism has gotten a bad reputation due to two problems, one is that its normally run by corrupt governments and leaders – and the second is that socialism in western countries tend to be about giving money to people who don’t want to contribute to society in any way (and indeed those who cant). There is nothing wrong with e.g. free healthcare to all people in a country, but it has to be weighed towards the necessary input in order for the system to be sustainable. It is as you say much based on the surplus of capitalism today – but it doesn’t necessary have to be so in the future. The problem we have today is that when people consume as much as they do today there is really very little surplus even for health care and other things so it becomes a question if we can afford it or not (which generally means rising taxes). Another problem is of course that people generally as so different that “freedom to choose” is basically a simpler system as people are free to choose to ruin their lives, with the natural side effect that we are also free to ruin the planet in our race to the top.

            The only real solution for any kind of sustainability is to try to define the absolute minimum a countries population need to to survive and then add some layers to make it a bit more pleasing (yes life was hard before, and we don’t need to go back to serfdom). But it seriously means cutting down a lot of what we take for granted now, like choosing to live 30 km+ away from work, owning your own car, travelling my airplane, bananas from Costa Rica, etc, etc. There is just a crazy amount of energy put into these rather stupid ideas we have of “living a full life”, which essentially keeps up the motivation for capitalism to thrive, and reduces the surplus for a social distribution of services. If enough people “get down to earth” and start thinking about their impact on the ecosystem and figure ways of limiting that, they will also notice that all these things we expect about life today are just icing on the cake and not really necessary. The power media and capitalism has on forming our ideas and expectations is really messing up any chance of improving the system as it is now.

            That is why we need serious regulations in how “bad habits” are marketed, everything from the removal of advertising everywhere (I have practically removed my exposure to that myself) to regulation of what kind of transportation is offered to the people. If a monetary system is in place (which usually helps cutting down time involved in swapping values), it needs to be seriously regulated and based on real physical assets. I know all of this sounds like a terrible communist food stamps kind of world, but the general idea here is really that if you give people freedom they then to squander it and leave ecological havoc in its place. There is really only one way to contain people and that is to limit their options, either forcefully – or preferably by free will and the acceptance of the truth – that the planet is finite and its our task to govern the resources as good as possible so that it can sustain human beings for thousands of years instead of a big party that lasts 100 years and leaves 90% of the species extinct at the end.

            • Don Stewart says:

              I think that socialism and capitalism are very poor choices in an energy constrained world. ‘Reforming’ either one isn’t likely to give us good results in the future. We have to look elsewhere for ideas.

              I suggest we begin with the Agrarian vision, which is currently championed in the US by Wendell Berry. In Wendell’s latest book, A Place In Time, he describes the working relationships which were common up until about 1950 in rural Kentucky. Most people farmed, they used horses or mules and did a lot of work with hand tools. Working together is frequently more satisfying than working separately (notice, this is not Taylorism and is not about the third decimal point of efficiency) and so voluntary groups of men would gather to work on each other’s farms. In my childhood, women got together on ‘wash day’ for some socializing. What you will notice, if you think about it, is that nobody is assigned to a work gang (as in communalism), nor is anyone treated as a ‘factor of production’. Those who won’t work or are exceptionally hard to get along with are just left out. Theft would be punished by exclusion. But within the group, you would likely find generosity and good will.

              What Wendell is describing is not what we have come to call capitalism:

              It is not about money as the ultimate value, about making money with money, about abusing other people to make money, about abusing Nature to make money, about the construction of financial derivatives, or a lot of the other phenomena which dominate the modern world.

              Agrarianism failed for many reasons around 1950, but the enabler was the sudden abundance of fossil fuel energy and the machinery it made possible. Even in its heyday, Agrarianism was not the only thing in people’s lives. They still had to cope with the Duke Tobacco Trust when they went to sell their cash crop, and the local horse trader was a necessary but not exactly savory occupation.

              As I see it, our challenge now is to pick over the ruins of previous civilizations and try to sort out what worked and what didn’t and what will be likely to succeed in the future. I suspect that we will find more useful ideas in the Agrarian society than in a Chinese commune or in a TBTF bank or by studying the life history of Carl Icahn. We need to know more about seed saving and we can forget about tens of trillions of dollars of derivatives.

              Toby Hemenway’s recent guest post discussed the reasons why Agriculture is ultimately destructive. I think that treating humans as mere ‘factors of production’ is similarly destructive. Centralization is another destructive practice. If we can clear away the debris, perhaps we can construct a satisfying society.

              I have just begun to serve on the board of a community garden. So far, I like what I see. People are assigned an individual plot to do with as they like (subject to rules about pesticides). But everyone is required to do some work on plots which are dedicated to growing food for a food bank and to participate in a couple of work days each year when we take care of the commons. We end the year with a picnic. Would an ideologue call this Socialism? Capitalism? Freedom? Communalism? Eco-terrorism? Sensible ecological and commons rules?

              My advice to everyone is to turn down the noise (or tune it out by turning off the media) and get involved in something satisfying and productive.

              Don Stewart

          • Don Stewart says:

            Dear BC
            Just out of curiosity, are you the same BC that Charles Hugh Smith frequently cites?
            Don Stewart

    • THank you very much for your very well-researched reply! I hadn’t looked at things quite that way.

      I think that you make an important point when you say that the cost share of oil cannot be disassociated from the cost share of the capital that transforms the oil into useful work. You mention cars, busses, planes and ships. I would add roads, bridges and railway tracks. These costs are rapidly increasing, as the cost of asphalt increase and the cost of steel increases. Also, there are attempts to increase mileage of vehicles, and these tend to increase the front-end cost of vehicles.

      I suppose we have a whole another set of inputs related to the electricity resource.

      All of these seem to becoming more problematic to maintain.

      • Don Stewart says:

        If, instead of starting from GDP, we begin with fundamental human goals and then calculate the effect on GDP, we get an interesting perspective.

        For example, consider ‘cruising’ (as depicted in American Graffiti), sitting on a bench on the town square (as memorialized in the song Standing On the Corner, Watching All The Girls Go by), watching pornography, going to singles bars (as depicted in Looking For Mr. Goodbar), becoming extraordinarily wealthy so that one can attract the opposite sex (as exemplified by Warren Buffett or Donald Trump), and engaging in social media–I won’t have anything to say about that healthy and productive pasttime of commenting on OFW.

        All those are ways to accomplish some rather complicated human goals. But they have very different costs. All of them are attempts to stir up some feel-good hormones, which they can all do with varying degrees of success.

        If we are trying to calculate the cost of crusing, we have to consider the cost of the gasoline, the cost of the car, the cost of the highways, the cost of the burger joints, the costs the burger joints inflict on our health, the cost of the pollution, etc. We could also differentiate the costs between those borne by the participant and those externalized to society.

        If we compare cruising with watching pornography, we can see some immediate advantages. (Sharon Astyk has said that pornography may be a big winner from Peak Oil). Of course one saves the gasoline. But part of cruising is having a more impressive vehicle than anyone else. So the temptation to buy a more impressive car is definitely one of the costs of crusing. The pornographers don’t care whether you even have a car. The costs they extract are more subtle. You must expose yourself to noxious commercials and, being human, you are likely to succumb to some of the blandishments. I would guess that the GDP associated with cruising for feel-good hormones is several multiples of seeking those hormones through pornography. I doubt that either one has a really big payoff in terms of cost.

        As gasoline and cars increase in price, then hormone seekers will gravitate toward pornography and away from cruising. GDP will fall. And GDP will fall not only because people will cut back on gasoline, but also because teenagers will buy fewer impressive automobiles and patronize burger joints less. In short, we have to look at the set of behaviors which are implied by a particular method of stimulating some sought-after hormones.

        Let’s contrast this 21st century situation with that of a young man and young woman in 1935. They live on farms. Someone in town is giving a dance. These young people have a need to meet each other which goes back to Adam and Eve. So they take the family Model A and drive into town wearing the best clothing their mother has made for them. They spend very little money. If the price of gasoline goes up, then they will still want to go to town to the dance….So one way I make sense of what has happened is to observe that in the Post WWII boom, oil facilitated a lot of expensive ways to solve problems. I see those expensive ways as under pressure for everyone except the One Percent. As oil increases in price, lower cost solutions will be favored. As I have pointed out before, the lower cost solution isn’t necessarily ‘worse’ in some absolute sense except that it means debts will not be repaid and money won’t necessarily generate more money. We may be on the long downslope leading back to church or grange dances.

        Don Stewart

        • Don Stewart says:

          As another example. In his wonderful book The Old Ways, Robert MacFarlane quotes John Brinckerhoff Jacson–a man constitutionally incapable of Romanticism: ‘For untold thousands of years we traveled on foot over rough paths, not simply as peddlers or commuters or tourists, but as men and women for whom the path and road stood for some intense experience: freedom, new human relationships, a new awareness of the landscape. The road offered a journey into the unknown that could end up allowing us to discover who we were’.

          So…to discover who we are we can choose between:
          -A pilgramage to Canterbury or Mecca or the Talladega Raceway
          -Solitary or companionable walking on the downs of England or the Long Trail in Vermont
          -Getting to know intimately the woods near our house or in Prospect Park
          -A cruise around the South Pacific
          -A guided safari to Africa
          -Working on a succession of small farms around the world or building houses for Habitat
          -Climbing mountains
          -Climbing in a building on an artificial wall

          You can trace through the impacts of these various choices in terms of GDP and pollution and externalized costs, you can speculate about the likely payoff of each strategy, and you can make your own choice based on what you think the lasting payoff will be. As oil and money become scarcer, it will probably pay dividends if you keep in mind the alternatives and don’t spend too much time grieving for the lost African Safari or South Seas cruise.

          Don Stewart

          • BC says:

            Brilliant, Don. Thanks.

            Following the advent of birth control, men’s orgasms became less costly to him and the female receptacle, assuming one or both of the partners were protected from the intrusive sperm cells.

            However, despite various means of proactively interrupting the flow of seminal fluid containing sperm cells to fertile ova, the cost of birthing and rearing offspring to adulthood is prohibitively costly for most couples (the divorce rate for couples with children is 35-40% higher than couples without children), and, by extension, so, too, is the cost of increasingly more people on a finite, spherical planet.

            Regarding who we are and the cost, about 50% of employment in the US is associated with females working full or part time to be able to afford wardrobe, a second car, child care, meals out at work, and other associated costs TO BE ABLE TO AFFORD TO WORK FOR PAY. Miles driven per capita and household, retail sales, payroll tax receipts, higher rents and house prices, no time with the children, fewer jobs for males at compensation sufficient to support a family, divorce attorney fees, and so on are all a consequence of gross mass-social inefficiencies of the mass-consumer, “feminized” society and economy.

            Consider that the average wage/salary of a college graduate of $44,000 today is equivalent to minimum wage in ’70-’81 in actual purchasing power terms when one includes the increase in payroll taxes and housing costs per household over the period.

            In other words, it requires a university credential today to obtain (if you’re the 50% of grads who receive a job offer) an equivalent of a minimum-wage job in ’70’81 purchasing power terms.

            Needless to say, the peak-Oil Age, post-WW II auto- and oil-based economic model no longer serves the needs of the vast majority of the population. Young people would be well advised to reject the current mass-consumer system utterly and redefine self-identity, material expectations, consumption per capita, reproduction, and their relationship to the biophysical/ecological system.

            R-evolution’s calling, and it begins inside one’s skull.

            • I might point out that in at least a few cases, it is the woman’s salary that pays most of the family costs.

              I agree that costs have changed a lot. Part of the problem is the greater number of bells and whistles being added to everything–houses (more square feet, higher ceilings, more yard and landscaping), cars (air conditioning, 5 MPH bumpers, antilock brakes), colleges (apartments instead of dorms, lots of administrators, lots of emphasis on research rather than teaching), stores (mare variety of stuff than anyone would want or need). You can sort of tell what era I came from. I don’t think anyone is any happier for all of the additional stuff.

        • Hopefully that is the way things work out.

          I think we need to be learn to be happy in whatever circumstance we are dealt–find the silver cloud, or at least see the positive things for today–how clear the sky is; how nicely the birds are singing; what basic needs are being met. We will likely need to learn to become more flexible as circumstances change. We may need to move and learn new skills, for example.

    • GermanStacker says:

      Also, we begin to understand the ambivalence in the economic rise of China and other developing countries. On the one hand, the negative feedback cycle in traditional economies would be already much more advanced without the new demand of emerging markets. On the other hand, the enormous energy needs of these countries bring new problems. Germany’s export industry (exploding profits coupled with negative real wages since 1990) is a very good example.

      • BC says:

        GermanStacker, the “China Miracle” is a story of US and Japanese supranational firms’ $4 trillion of investment in China-Asia over the past 20-25 years or so. Had this not occurred, there was not the organic wealth, technological deepening, nor resources to permit the “miracle”. The high cost of energy and food today is directly the consequence of the West’s “development” of China-Asia as a production colony for western consumers, and now a consumer market.

        However, China has reached the “middle-income trap” phase of development, is 40-80 years too late to the auto- and oil-based economic model, and faces secular demographic drag effects such as those that began in Japan in the ’90s and the US in the early ’00s. China’s growth boom is over, and the structural drag effects on China will last into the early to mid-’20s and well beyond.

        • GermanStacker says:

          These are very good points. As to the boom in China being over, it seems their numbers may be overstated and it is also often said that they have a credit bubble, but for the next 10 years they seem to be still growing quite a bit. Pollution and health could become very serious issues in China.

  4. Pingback: Gail Tverberg: How High Oil Prices Lead to Recession »

  5. Yesterday, January 30, 2012 the Doomstead Diner passed the 2,000,000 mark in Page Hits in our first year of operation. Average DAILY page hits now are around 9000. This is close to what Mish or Karl get.

    My thanks to Gail for allowing me to Cross Post her Energy Analysis on the Diner.


  6. Pingback: How High Oil Prices Lead to Recession | Doomstead Diner

  7. JT says:

    Question for you Gail: if high oil prices are creating a drag on the economy, why aren’t we seeing that show up in inflation, i.e. higher price levels for everything? That is, aside from the increase in oil price, where else can we definitively point to the drag of oil prices?

    • Ian Schindler says:

      In my view, the inflation is in asset prices: stocks, bonds, real estate, etc. According to this article:, the government bailout of the financial sector in 2008-2009 amounted to much more than the $700 billion TARP funding. The authors of the above paper found (after a careful audit of publicly available material) that the bailout was actually $29 trillion. Similarly, in Europe, when the European Union says they are saving Greece, they are actually trying to save Greece’s creditors, that is, the European financial sector. The financial sector holds lots of assets that in my view are very much over valued in the sense that if people tried to exchange these assets for hard commodities such as oil, wood, steel, etc. There would be huge inflation in the prices of these commodities.

      The 400 richest individuals in the US control as much wealth as the bottom 23%. My theory is that someone making $4 million a year probably does not consume 100 times more oil than someone making $40,000 a year. The person making $4 million a year buys assets that are theoretically exchangeable for commodities, but in practice I doubt that they could be. That is, I think that the paper wealth of many individuals is much lower than they believe.

      The poverty rate is climbing. The middle class (by which I mean the class of people able to run a car or afford other energy assisted transportation and live in a HVAC’ed living space) is decreasing in the US and Europe. This puts a drag on prices. The dynamics of the system are as follows, high prices reduce the middle class causing downward pressure on prices, low prices reduce production causing an increase in prices. That’s why I talk about a feedback loop that was positive while oil production was increasing which has stalled and is in the process of swinging negative. We had an increasing middle class, it has been stagnant for several years and will soon begin shrinking.

    • The big impact of high oil prices is on employment, or lack thereof. Because of high oil prices, businesses have price pressure to raise the prices of the products they sell, but workers are not getting wage increases, so cannot really pay these increases. In order to keep income/ outgo in line, businesses either end up outsourcing more work to third world countries to keep costs down, or they close whole segments–unprofitable routes for airlines, or unprofitable restaurants, for example. These changes lead to employment loss, rather than price increases.

      The other big impact is on government finances, because governments need to borrow money to make up for the lack of taxes from the unemployed people, and pay them benefits. To try to hide the horrible impact of the additional debt on government finances, the governments resort to QE, to keep interest rates artificially low (so the carrying costs of government debt is lower), and to try to stimulate investment. To the extent there is inflation, it is in bond prices, because of the absurdly low interest rates, and in stock prices, because of the low interest rates available in the bond market and few investments providing adequate return.

      Edit: Food prices, asphalt prices, airline tickets, herbicides and pesticides, and variety of other goods where the oil price rise can be passed on rise in price as well.

      • Now, that you’re read Tverberg “facts,” here are the real facts:

        “These changes lead to employment loss, rather than price increases.”
        Wrong. Oil prices dictate inflation. See:

        ” . . . governments need to borrow money to make up for the lack of taxes from the unemployed people, and pay them benefits.”
        Mostly wrong. It is true for monetarily non-sovereign governments like Chicago, Illinois and Greece. It is not true for our Monetarily Sovereign government which uses neither tax dollars nor borrowed dollars to support its spending. (Also not true for other Monetarily Sovereign nations like China, Canada, Japan, Australia et al.)

        I repeatedly have asked Gail to try to understand the differences between Monetary Sovereignty and monetary non-sovereignty, but to no avail. Instead, she prefers to provide incorrect information. She could see a brief outline of Monetary Sovereignty at:

        Her comments not only are wrong, but harmful to the 99%.

        • Ian Schindler says:

          With respect to job losses and inflation, I agree with both of you, as does empirical evidence. Note however that job losses will mollify the effect of inflation. It is true that increased oil prices increase marginal production costs of many items thus causing inflation. In 2008 the price of oil hit $150 a barrel raising the price of many other goods (notably food). The price then decreased to $40 a barrel because of the recession the high price caused.

          With respect to governments borrowing money, Gail’s sentence would be correct if she dropped the “need”. Under the current system, that’s what governments do. They could decide to move to a different monetary system, but I don’t see them doing that until the current system fails. Even Iceland is going to credit markets to finance government spending.

          • Ian,

            I believe there is some semantic confusion. Although federal law required the Treasury to issue Treasury securities in the same amount as the deficit, this is not “borrowing” as it normally is understood. The government neither needs, nor uses nor even receives the so-called “borrowed” funds.

            For example, when China “lends” to the U.S. (i.e. invests in Treasury securities), it follows this simple protocol:
            1. It deposits already existing dollars into its checking account at the Federal Reserve Bank
            2. It instructs the FRB to transfer those dollars from its checking account to its T-security account, also at the FRB. The process is identical with you instructing your bank to transfer your money from your checking account to your savings account.

            At the time your bank makes that transfer, would you consider that you have just lent them money? While the bank owes you all money on deposit, that money is not a burden on the bank, in the same way a normal debt is a burden on the debtor.

            The fact is that the so-called “debt” is not used by the federal government to pay its bills. It’s important to understand that there can be debt without deficits, and there can be deficits without debt. The two are not functionally related.

            By contrast, monetarily non-sovereign governments do borrow to pay their bills. This misunderstanding is what has caused the unnecessary and damaging effort at austerity.

            When President Obama says we need to reduce the debt, he is lying.

            • Ian Schindler says:

              You make an excellent point Rodger. I still think there are some problems with transferring money to a T-bill account, the most important of which is that the government pays interest on the T-bill account. More fundamentally, I think there will be problems with our current monetary system, because it was designed to work in the presence of economic growth. In the absence of economic growth, I think the current monetary system will eventually collapse.

              You also speak of the 99%. Here you are talking about fairness and equal distribution of wealth. How does this effect the finiteness of our resources? I think it is clear that we have slid into a class system which is highly unfair. For example HSBC gets fined $1.9 billion (about 5 weeks of income) and no criminal convictions for years of laundering Mexican drug cartel money while Cameron Douglas got a 5 year prison sentence for simple possession. What is the effect of this inequality on oil production? In my view wealth inequality would have a tendancy to speed the arrival of peak oil by decreasing the size of the middle class, the class which spends the greatest proportion of it’s wealth on oil. This lowers the price of oil which in turn will decrease production. I also believe that austerity will not balance books, and will bring on peak oil sooner for the same reason. I debate with myself whether it is better to fight for a fair and just system, or let the unfairness lead to a faster collapse of the entire system after which we can try and design something better.

              In any case, I warn people to plan to get by with less in the near future.

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