Why we get bad diagnoses for the world’s energy-economy problems

The world economy seems to be seriously ill. The problem is not overly high oil prices, but that does not rule out energy as being a major underlying problem.

Two of the symptoms of the economy’s malaise are slow wage growth and increasing wage disparity. Tariffs are being used as solutions to these issues. Radical leaders are increasingly being elected. The Bank for International Settlements and the International Monetary Fund have raised concerns about the world’s aggregate debt levels. The IMF has even suggested that a second Great Depression might be ahead if major banks should fail in the manner that Lehman Brothers did in 2008.

Figure 1. Ratio of Core Debt Growth (non-financial debt including governmental debt) to GDP, based on data of the Bank of International Settlements.

If the economy were a human being, we would send it to a physician for a diagnosis regarding what is wrong. What really is needed is a physician who has a wide overview, and thus can understand the many symptoms. Hopefully, the physician can also provide a reasonable prognosis of what lies ahead.

Individual specialists studying the world’s economic and energy problems tend to look at these problems from narrow points of view. Some examples include:

  •  Curve fitting and cycle analysis using economic data by country since World War II, as is often performed by economists
  • Analysis of oil supply based on technically recoverable reserves or resources
  • Analysis of fresh water supply problems
  • Analysis of population problems, including rising population relative to arable land, and rising retiree population relative to working population
  • Analysis of ocean problems, including rising acidity and depleting fish stocks
  • Analysis of the expected impact of CO2 production from fossil fuels on climate
  • Analysis of rising debt levels

In fact, we are facing a combined problem, but most analysts/economists are looking at only their own piece of the problem. They assume that the other aspects have little or no influence on their particular result. What we really need is an analysis of the overall economic malady from a broader perspective.

In some ways, the situation is analogous to having no physician with a sufficient overview of where the world economy is headed. Instead, we have a number of specialists (perhaps analogous to a psychiatrist, a urologist, a podiatrist, and a dermatologist), none of whom really understands the underlying problem the patient is facing.

One point of confusion regarding whether today’s oil prices should be of concern is the fact that the maximum affordable oil price seems to decline over time. This happens because workers around the world increasingly cannot afford to buy the goods and services that the world economy produces. Inadequate wage growth within countries, growing globalization and rising interest rates all contribute to this growing affordability problem. To make matters confusing, this growing affordability problem corresponds to “falling demand” in the way economists frame the issues we are facing.

If we believe the technical analysis shown in Figure 2, the maximum affordable West Texas Intermediate oil price has declined from $147 per barrel in July 2008 to $76 per barrel recently. The current price is about $62 per barrel. The chart suggests that downward price resistance might be reached at $55 per barrel, assuming no major event occurs to change the current trend line. Any upward price bounce would appear to leave the price still much lower than oil producers need in order to reinvest sufficiently to allow future oil production to be maintained at current levels.

Figure 2. Down sloping diagonal line at the top of chart gives an estimate of the trend in maximum affordable West Texas Intermediate (WTI) oil prices. The downward trend line starts in July 2008, when oil prices hit a maximum. This high point occurred when the US real estate debt bubble started unwinding. Later maximum points correspond to points when oil prices stopped rising and crude oil reservoirs started refilling. Chart prepared by Amit Noam Tal.

Thus, our concern about adequate future oil supplies should perhaps be focused on keeping oil prices high enough. It takes a growing debt bubble to keep oil demand high; perhaps our concern should be keeping this debt bubble high enough to allow extraction of commodities of all kinds, including oil. Figure 1 seems to show a recent downward trend in Debt to GDP ratios for the Eurozone, the United States and China. This may be part of today’s low price problem for commodities of all types.

Needless to say, climate analyses do not consider the severity of our energy problems, nor do they consider the extent to which there is a connection between energy supply and the ability of the economy to operate as usual. If the real issue is a near-term financial crash that will radically affect future fossil fuel consumption, the climate analysis will certainly miss this event.

The Real Nature of the Limits to Growth Problem

To truly understand the headwinds that the economy is facing, we should be looking at the combined effect of all of the limits that the individual specialists have been studying. We might also include other issues not listed. The 1972 book The Limits to Growth presents an early computer model of how at least some of the limits of a finite world might be expected to play out.

Figure 3. Base scenario from 1972 Limits to Growth, printed using today’s graphics by Charles Hall and John Day in “Revisiting Limits to Growth After Peak Oil” http://www.esf.edu/efb/hall/2009-05Hall0327.pdf

This early approach reflected an engineering view of the problem, considering expected diminishing returns with respect to resources of all types. Other considerations included likely resource needs based on prior economic and population growth trends and efficiency gains. The Base Scenario shown in the 1972 book (Figure 3) showed collapse taking place about now–in other words, in the early part of the 21st century.

In the time since the 1972 Limits to Growth analysis was prepared, there has been a major discovery relating the importance of energy to the economy. Ilya Prigogine tackled the problem of the physics of thermodynamically dynamic open systems, earning a Nobel Prize for his efforts in 1977. When energy flows are available, many structures, called dissipative structures, can grow and change over time. Examples include plants and animals, hurricanes, stars (they expand in size, then collapse at the end of their lives), ecosystems, and economies. These structures are utterly dependent on energy flows. The economy needs energy in almost the same way that humans need food. Without sufficient energy flows, the world economy will collapse.

It is because of the laws of physics and energy flows that markets are able to set price levels. Indirectly, physics sets the maximum affordable price for energy products based upon the total quantity of goods and services individual workers can afford. These maximum affordable prices may be invisible, but they are very real. Economists may talk about “demand” for energy products, but the real issue is affordability: “Will the laws of physics allow prices to stay high enough to provide the commodities the world economy needs?”

It is because of the laws of physics that debt can play a major role in the economy. Debt can provide time-shifting services if an economy does not have sufficient energy supplies to permit the equivalent of bartering of finished goods and services for new capital goods. Debt can allow future goods and services (manufactured with energy products) to serve as payment for capital goods and other goods purchased using debt. Thus, debt acts as a promise of future energy supplies. These future energy supplies may not, in fact, actually be available at prices that consumers can afford. This is why debt bubbles so often collapse and have a devastating impact on economies.

In theory, the new physics discoveries might also be added to the Limits to Growth model. If this were done, I would expect the downslopes in Figure 3 to be much steeper. Also, the date when the population decline starts would likely move forward, relative to other declines. The actual dates of the declines would of course be expected to change as well, because of updated knowledge regarding resources, population, and other factors.

Including the physics aspect of the economy would lead to many periods when sharp changes take place. When these sharp changes take place, there might be wars, collapsing governments, and epidemics, all causing large numbers of deaths. Debt bubbles might pop, causing deflation and widespread banking problems. These types of events are similar to those that economies have experienced in the past. There is no reason to expect that today’s world economy will have unusual lasting power.

Of course, modeling one piece of the economy at a time, as described at the beginning of this post, leaves out such troublesome implications. Economists tell us all we need to worry about is price fluctuations as the economy substitutes one product for another. If a person has blinders on, perhaps this a good description of the world we live in. Otherwise, the model leaves a lot to be desired.

Implication of the Laws of Physics Being in Charge of How the Economy Operates

Politicians would very much like us to believe that they are in charge. They would like us to believe that adding more technology can solve all of our problems. They would like us to believe that citizens can make a significant difference by voluntarily cutting back on their own energy consumption. They would also like us to believe that countries can cut back on their debt levels without the whole Ponzi Scheme unraveling.

Anyone who has watched bread rise in a bowl can see the implications of growth within a finite structure. It doesn’t take very long for the volume growth of bread dough to exceed the space available. Even if the bread maker pushes the dough back down again, the effect is only temporary. The bread dough quickly rises again to overfill the bowl it is in.

One possible implication of the 2008 financial (and oil price) crash is that we are very close to limits, right now. Regulators can try to fine tune how the economy operates by raising and lowering interest rates (sometimes using Quantitative Easing (QE) in the process), but they are, in some sense, playing with fire. Figure 4 shows the dramatic impact that popping the real estate debt bubble seems to have had in 2008. It also shows the impact that adding and removing QE has had.

Figure 4. Figure showing collapsing debt bubble at the time US oil prices peaked. Figure also shows the use of Quantitative Easing (QE) to stimulate the economy, and thus bring oil prices back up again. Ending US QE seems to have had the reverse effect.

By raising interest rates, regulators could easily send part, or all, of the world’s economy to a financial crash that is worse than 2008’s. Or the economy could again reach limits, by itself, with just a little economic growth. In some sense, the world economy is very close to filling the bread bowl, as it was before the 2008 crash pushed it back down.

The World Economy Is Reaching Limits in Many Areas Simultaneously

Many people believe that we are reaching limits in at most a few areas of the economy, such as “running out of oil.” The evidence suggests that because of the networked nature of the economy, we are really reaching limits in many places, simultaneously. The following represent some problem areas:

(1) Too Low a Return on Labor for Workers Whose Jobs Are Easily Exportable. With globalization, workers are indirectly competing with workers around the world regarding who can produce goods and services most cheaply. They are also competing with computers and robots that can easily replicate their functions. The net impact is a world where a large share of the citizens find themselves living at a level not much above the subsistence level. In more developed countries, young people may live with their parents longer and may delay having children almost indefinitely, because wages are not keeping up with living costs. Many studies have shown rising wage disparity. In some ways, the wage disparity now seems to be as bad as in the 1930s.

Figure 5. U. S. Income Shares of Top 1% and Top 0.1%, Wikipedia exhibit by Piketty and Saez.

(2) Interest Rates. Interest rates are the lever that economists like to adjust upward or downward to try to stimulate the economy or push the economy downward. Short term interest rates, up until about the end of 2015, were at the level they were at during the Depression of the 1930s.

Figure 6. Monthly average 3-month term treasury bill rates in chart prepared by FRED. Amounts shown through October 2018. Grey bars indicate recessions.

Raising interest rates is like adding a little more dough to the already over-full bread bowl. With these higher interest rates, borrowers need to pay more for monthly payments, making the strain on their finances even worse than it was previously. Figure 6 shows that raising interest rates very often creates a recession. In fact, the Great Recession of 2008-2009 seems to be the result of an increase in short term interest rates. This time we are being told that the increase will be gentle, but if the bread bowl is already overly full (in the sense that affordability of the output of the economy is already way too low, for many workers), what difference does “gentle” make?

(3) Return on Capital Investment/Added Debt. Falling long-term interest rates between 1981 and 2016 seem to be an indirect reflection of falling long-term return on capital investment. If capital returns had been higher, there would be more demand for debt, forcing interest rates up to levels closer to where they had been when the economy was growing more quickly.

Figure 7. Monthly average 10-year US Treasury interest rates in chart prepared by FRED. Amounts shown through October 2018. Grey bars indicate recessions.

Another way we can look at how productive the addition of debt has been is by comparing the debt increase each year with the GDP increase (including inflation) each year. We use current year GDP as the denominator in both calculations. Figure 8 shows the indications for what the Bank for International Settlements calls “Core Debt” (that is, Total Non-Financial Debt, Including Government Debt).

Figure 8. Dollar Increase in US Core Debt as % of GDP, shown beside GDP dollar increase, as percentage of ending GDP. Amounts based on FRED data.

Comparing the red and blue lines on Figure 8, GDP rose fairly reliably in the pre-1981 period, as the amount of core debt rose. The core debt increases tended to be higher than the GDP increases, but not a great deal higher. Thus, the US ratios on Figure 1 could be close to 1.0 in early years.

Once interest rates started falling after 1981 (see Figures 6 and 7), core debt growth and GDP growth greatly diverged. I expect that quite a bit of this change was related to asset price inflation as interest rates fell. With lower interest rates, assets of all types started becoming more affordable. Thus, a greater number of buyers could be expected, driving up prices of assets of all kinds, including homes, stores, and factories. Owners of these assets could “take the equity out” as prices rose and could use the equity to purchase other goods and services. In theory, these activities might somewhat stimulate the economy. Figure 8 suggests that the benefits of these activities with respect to the “goods and services” portion of the economy (red line) were slight at best, however.

Figure 9. Dollar Increase in US Financial Debt as % of GDP, shown beside GDP dollar increase % of ending GDP. Amounts based on FRED data.

Figure 9 shows Financial Debt amounts corresponding to the Core Debt amounts shown in Figure 8. At first glance, it appears that Financial Debt (blue line ) has provided no benefit whatsoever for the Goods and Services part of the economy (red line). But clearly the bankers who created these financial products benefitted from the income they received from them. So did the low-income home buyers who bought homes that they could not really afford in the early 2000s. Home building was stimulated, and inflation in home prices was stimulated. Banks benefitted by being able to transfer their problem home loans to unsuspecting buyers. Whether this whole arrangement had any net benefit to the economy, other than to create pseudo-solutions for people who could not really afford the homes they were purchasing, is doubtful. But when the economy is near limits, strange solutions to stimulating the economy are attempted.

(4) Commodity Prices. If we have a supply problem with one kind of commodity, we likely have a supply problem with many kinds of commodities at the same time. The reason why this happens is because the prices of many types of commodities tend to move together, in response to general market conditions. This is why the US government talks about inflation in oil and food prices as a separate category of Consumer Price Inflation.

If prices for commodities are generally low, as they have been since 2014, this means that commodity investors have received low rates of return for several years. With low rates of return, producers of many commodities have cut back on reinvestment. With inadequate reinvestment, supply crunches are likely to occur across a broad spectrum of commodities simultaneously. A recent Wall Street Journal article says, Supply Crunch Looms in Commodities Markets. The article mentions copper, zinc, aluminum and nickel. Other articles talk about oil in a similar fashion.

The question becomes, “Can consumers bid up the prices of all of these minerals sufficiently, to encourage enough reinvestment to solve the world’s commodity supply problem?” Food prices would likely need to be bid up as well, because oil is used heavily in the production and transport of food.

It was possible to bid up commodity prices in the 1970s, because the economies of the United States, Europe, Japan, and the Soviet Union were all growing rapidly. Also, women were joining the labor force in large numbers. It was possible to bid up commodity prices in the 2002 to 2008 era, because China and other Asian nations were rapidly ramping up their demand for goods and services of all kinds.

Figure 10. China energy production by fuel plus its total energy consumption, based on BP Statistical Review of World Energy 2018 data. The difference between the production figures shown and the black line consumption total is imports.

Now we are facing a much different situation. China is in much worse shape than most people recognize because its coal supply seems to have passed peak production. This has happened because the cheap-to-extract coal is mostly depleted, making it unprofitable to increase coal production without significantly higher prices. Imported coal and natural gas are expensive options. China also has a serious debt problem.

Because of China’s problems, the country will necessarily need to cut back on manufacturing, road building and home building in the years ahead. (This would happen, with or without Trump’s tariffs!) For some minerals, China currently represents over 50% of the world’s demand. China is the largest oil importer in the world. It is doubtful that China can make major cutbacks in its use of commodities without lowering prices for many commodities worldwide.

Persistence of Outdated Models

We are dealing with a situation where a large number of people suspect, at least vaguely, that the world economy is like bread dough about to outgrow its bowl, but this is not an issue anyone really wants to quantify. Everyone wants solutions; they don’t want a better delineation of the problem. Repeated publication of climate change forecasts is, in a sense, a denial of the possibility that we may be facing resource limits that are close at hand. Such publication is saying, in effect, that the closest limit that citizens need to worry about is the climate limit.

Also, the reliance of researchers on the past work by others in the same field tends to reinforce what are essentially incorrect models. Cross-pollination across fields is difficult, given the technical nature of today’s academic research. Furthermore, it becomes increasingly difficult to properly model a situation that is very complex and depends upon non-linear interactions.

Putting All of These Issues Together

The focuses of today’s narrow research can give a surprisingly distorted overview of where the economy is. A few areas in particular stand out:

(a) The choice of the word “Demand” instead of “Affordable Quantity” makes it sound like the buyer has more control over purchases than he really does. Growing demand seems to depend on continually increasing debt. This is the reason for the debt bubble problem.

(b) Framing the energy problem as “running out of oil” makes it sound like searching for substitutes will be a fruitful area for solution. Because of the affordability issue, this search is futile unless the substitutes are truly cheaper, when all costs are considered. Declining availability of many minerals because of persistently low commodity prices could be an issue as well.

(c) If limits are being reached in many areas simultaneously, incentives for countries to co-operate seem likely to go downhill quickly. Bullies who claim to be able to obtain a bigger share of the shrinking total supply will tend to be elected.

(d) The physics tie between energy and the economy makes major energy consumption cutbacks virtually impossible, without risking economic collapse.

(e) Adding technology isn’t really a solution to the debt problem, because it tends to make the affordability problem worse. The problem is that while adding technology seems to lead to more employment for a few elite workers, it tends to displace lower-wage workers at the same time. The spending of lower-wage workers is really needed if adequate demand for commodities is to be maintained. Additionally, the ownership of the technology-related capital goods tends to be concentrated among the elite; this further shifts wealth from the non-elite to the elite.

The long term prognosis for the world economy seems pretty grim, when all of these issues are put together. Defaulting debt and a resulting collapse in asset prices of all kinds is of particular concern. The default of subprime housing debt was an issue in the US at the time of the Great Recession; the next round of defaults is likely to start elsewhere. Debt defaults could start fairly soon, perhaps in the next 6 to 12 months. The more hostile political situation we have been seeing recently seems to be evidence that limits are close at hand.

 

 

 

 

 

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 financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
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1,576 Responses to Why we get bad diagnoses for the world’s energy-economy problems

  1. Fast Eddy says:

    First!

  2. Rodster says:

    Right now the global eCONomy is being held together with monetary and central banking superglue and duct tape. Eventually something is going to break free and when it does, good luck putting it back together because the central banks shot their wad in 2008 and there’s no more ammo available unless they decide to roll the dice and hope the global eCONomy doesn’t turn into Zimbabwe or the Weimar Republic.

    • Jarle says:

      “The way out going forward for China is to diversify its oil and gas supply mix as much as possible and continue to reach global joint development agreements with both national and international oil companies, an art that hydrocarbon deficient Japan, the world’s third largest crude oil importer, has executed brilliantly for decades.”

      No problem then.

      • Fast Eddy says:

        Japan is the model… for all those countries that have turned from exporting to importing oil… if everyone can adopt their model — all will be well … in the garden….

        Yemen… Egypt…. Mexico … are you listening?

        • I made a debt to GDP ratio graph for Japan, and it didn’t even fit on Figure 1 with the other countries. As far as I can see, Japan has used a huge amount of debt since the time that they started industrialization. This may have been for imported fuel and for nuclear power plants. Also, all of the factories and high rise homes. The debt blew a big asset price bubble. Once the bubble popped, both household debt and other non-governmental debt started dropping. Japan’s governmental debt started shooting through the roof, to try to make up for the shortfall in debt growth. Of course, it couldn’t really compensate for the debt growth lost, and the total debt was so high that it couldn’t keep leaping by big amounts. So Japan has been stuck with being on the edge of deflation, pretty much since the bubble popped.

    • Diversification may be the way out, but so far they are not doing well. This is an EIA chart of China’s monthly “Total Liquids” production and its monthly Crude and Condensate production.

      I think the tight oil is a long shot. They have quite high-cost resources otherwise. (The tight oil may be as well.) China decided to let some of the production decline, not too long after oil prices fell.

      China’s natural gas production has been rising, but from a small base. In 2017, China produced 62% of the natural gas it consumed, importing 38% of it. But natural gas amounts to only 6.6% of total energy consumption (primarily because coal is so huge).

      • Fast Eddy says:

        I reckon China should have a go at the Americans in Iraq and try to seize their oil fields.

        We could use a big war… it is entertaining.

        The MSM could make lots of money of ads when they broadcast 47/7 – the arms dealers would celebrate… this could be what is needed to get those green shoots sprouting.

        Remember green shoots? How many thousand times did we hear that phrase in 2009?

  3. Fast Eddy says:

    I have been percolating this one for a few days now…

    Think about the following statement…. think about the art of propaganda…. think about how people trust the BBC….. think about what happens inside their brains when they read this…. think about the power of that statement….. the influence it has on readers….

    As I have posted this is NOT settled.. not even close…. there are loads of eminent dissenters.. there is a whistleblower who has written a lengthy dissertation explaining how the scientists faked the data….

    But nope – the BBC will NEVER publish that dissertation …. NEVER. Nor will any other MSM outlet.

    What we get is instead… is this:

    ‘It’s settled science that kkklimate cccchange is real’

    http://www.bbc.com/future/story/20181102-what-can-i-do-about-c

    limate-change

    Surely that should set the alarm bells ringing…. this is Propaganda 101….

    • xabier says:

      The BBC is a comedy show: I unfortunately heard a radio report recently on ‘smart homes’, which will apparently save the world – ‘zero-emissions’, etc, etc.

      The ‘journalist’ ended with ‘Well, I’d just love one of those smart homes, wouldn’t you? I can’t wait!’

      After listening to that tripe, all one has to do is walk out of the door and look at what is actually being built now, all very un-‘smart’.

      • xabier says:

        PS Thank you, Gail!

      • Fast Eddy says:

        The mind is a fascinating thing…. one can see the obvious signs of environmental and economic collapse… yet if the MSM says the future is one of smart homes EVs and clean energy…. we grasp onto that …. as desperately as…

      • zenny says:

        I like tripe and I use BS in my garden. The new homes in my market are Huge and also built like junk.

        • Fast Eddy says:

          My experience in western property markets …. people want BIG poorly constructed rubbish vs medium or small well put together homes….

          Never build a well-constructed home of any sort — nobody wants small houses like that…. and few can afford large houses built like that.

  4. Fast Eddy says:

    We all know full well that:

    1. EVs are charged mostly fossil fuels – particularly coal. So they are NOT green.

    2. EVs are manufactured using huge amounts of fossil fuels…. and they all carry toxic batteries.

    3. It is impossible to convert even a small fraction of the ICE fleet to electric – there are not enough rare earth materials

    4. Without subsidies EVs would be ridiculously expensive and nobody would buy them.

    Yet…. we have these pronouncements at the very highest levels of government ….and most people believe them…. which demonstrates how easy it is — if there is a will and a reason — that a massive lie .. can be turned into a truth…

    Try arguing with an EV-believer explaining how this is NOT possible…. good luck!

    Feel free to jump in on the comments … and be run out of town very quickly…

    And notice from the comments how this quickly gets tied in with the kkkk ccchhhh narrative…

    Because that is the point…. the MSM has done an excellent job convincing the masses…..

    In 2017 a rash of targets to constrain fossil fuels for cars led Forbes to declare it to be “The Year Europe Got Serious about Killing the Internal Combustion Engine.” In 2018, even more European countries have joined the list, stating their intent to end the sale of new petroleum vehicles at some point between 2030 to 2040. Also this year, the trend has expanded out of Europe to Israel, Costa Rica, and Taiwan, with targets as early as 2021. Over the same three years, 2016 to present, 20 metropolitan areas from these and other countries announced their own plans to end the use (not just sale) of gasoline and/or diesel vehicles, and mostly before or by 2030.

    What is more remarkable, China and India, the titans of demand growth, both declared similar intentions in 2017. China announced its study of a plan to end sales and production of oil-burning cars by 2040, and India asserted it wants to end new sales by 2030. The plans are not enforceable as law (yet), either in Asia or in Europe, and electric vehicles currently constitute only a trivial portion (1 to 1.5%) of vehicles in China and India. The discrepancy between target and current reality, though, points less to the improbability of perfection as it does to the political will for progress. And progress alone, not perfection, is sufficient to trigger peak demand and the tectonic shifts that go with it.

    https://wolfstreet.com/2018/11/05/the-acceleration-towards-peak-oil-demand/

  5. Eric Zencey says:

    Gail—

    Below and linked Here’s my short take on why we get bad diagnoses for the world’s energy-economy problems. Please do feel free to refer to it if you think it has merit. Capsule summary: oil’s incredibly high EROEI insulates economic theory from reality.

    Eric Zencey

    Fellow, Center for Research on Vermont and Center for Rural Studies
    Coordinator, Vermont Genuine Progress Indicator Project
    Adjunct Associate Research Professor, Political Science, retired
    University of Vermont
    Burlington, Vermont

    Research Fellow
    College of Architecture
    Graduate School of Architecture and Urban Design
    Washington University in St. Louis
    St. Louis, Missouri

    Typos, misspellings, odd capitalizations are courtesy of my dictation program

    The Daly news June 3, 2015

    The future history of political economy, part one: Economics Ignores Thermodynamics
    by Eric Zencey

    Editor’s Note: An earlier version of this essay appeared as a comment in the Great Transition Network Forum, which will appear on the Great Transition Initiative website next week along with a new essay by Herman Daly, “Economics for a Full World.”

    [Eric Zencey]Ecological Economics and its corollary, Steady State Economic thinking, represent a step forward for the discipline of economics and also a return to how it was practiced in the past. In the nineteenth century, economics was a part of a larger enterprise: political economy, the integrated treatment of morals and economics, ultimate ends and efficient means. Late in that century economics calved off from political economy, leaving behind political science and political philosophy as the residuum. It did this in service to the ideal of becoming rigorously scientific.

    It’s odd, then, that alone among disciplines with any pretense to analytic rigor, economics has steadfastly resisted the thermodynamic revolution that swept physical and life sciences in the nineteenth and early twentieth centuries. Physics, biology, chemistry, geology, even the study of history were transformed, but not economics.

    I think we can blame this on bad timing, willful ignorance, and oil.

    Bad timing

    In the late nineteenth century the archetypal science was physics and physics was Newtonian mechanism. Ignorant of what a young thermodynamic theorist named Albert Einstein would soon do to the Newtonian paradigm they emulated, Stanley Jevons and other economic “scientists” set about mathematically modeling the economy as sets and subsets of self-contained, equal-and-opposite actions and reactions, happily (and explicitly) assuming that all economic activity consists of ahistorical, which is to say completely reversible, processes. No one who has a nodding acquaintance with the law of entropy could have countenanced this. Entropy is Time’s Arrow, the law of irreversibility; it describes the one-way flow of energy use. A purely mechanical process can be run forward or backwards, but we’ll never invent a machine that can suck in exhaust gases, heat and motion and transform them into gasoline. The entropy law can tell you why. Newton couldn’t.

    Just as a consumer might choose to keep a recently purchased appliance even though a newer, better model has been brought onto the market, neoclassical economists weren’t about to re-tool their brand-new thinking to reflect changes in the underlying metaphysics they had been so keen to adopt. It didn’t seem to them that there was any reason to.

    “Seem” is the operative word here. Because the entropy process is time’s arrow, and because Ecological Economics places the entropy process at the center of its analysis, it’s entirely appropriate for Ecological Economics to understand its subject matter and itself as a discipline in historical terms. Like other paradigm-defining insights, this one seems obvious once it has been stated: elements of the neoclassical model that could pass for true on a large and forgiving planet a hundred years ago are obviously not true today, when the planet’s source-and-sink services are severely taxed, when natural capital is the limiting factor in production, when there are seven billion of us and our economic wants, capacities and expectations have been amplified by our access to the ancient sunshine of fossil fuels.

    Willful ignorance

    By modeling the economy as a closed and circular system, neoclassical economists have encouraged themselves to operate in a methodologically enforced state of denial about the physical roots and ecological consequences of our wealth-creating activities. And yet economics has experienced no paradigm-shaking crisis as a result. Neither climate change nor any of the other source-and-sink catastrophes facing civilization have been laid at the feet of bad economic theory. One reason: Neoclassical economists succeed in treating environmental costs as “externalities.” How could environmental degradation be the result of economic activity if it’s external to the economy?
    [Midas.Giovanni Caselli from the Age of Fable]

    The power to create wealth gave Midas an unsustainable life as a complete solipsist. Oil’s power to create wealth has had a similar effect on Neoclassical economics. Illustration by Giovanni Caselli from The Age of Fable.

    In its self-confirming isolation of the economy from nature and theory from reality, neoclassical economics amounts to a highly principled practice of solipsism. When this pathology is manifest in an individual it produces unpleasant consequences that might eventually prompt some reflection and personal growth. Not so with the collective delusion of mainstream economists. Evidence of our ongoing ecological catastrophe falls far from their purview—not just disciplinarily but geographically, as the wealthier nations (wherein the vast majority of economists reside) export their ecological footprint to the impoverished nations of the world. And for several generations (at least since Reagan defeated Carter, removed Carter’s solar panels from the White House and ushered in an era of GDP growth through de-regulation of the social and ecological consequences of economic activity), there has been a strong self-selection among students of economics. Undergraduates with any kind of deep personal connection to natural systems tend to find the study of standard economics unattractive, displeasing, even soul-deadening. This leaves the field to those most willing to bracket off as irrelevant to their professional purpose any question about the moral and ethical consequences of economic activity, any question about the health and maintenance of nature, any question about the economy’s relation to the larger social and natural systems within which it operates.

    Oil

    Even so, you might expect that a discipline with such a demonstrably deficient view of its subject matter would fail of its object—would fail to offer wise counsel about the collective project of augmenting the stock of wealth that humans can enjoy. But economics has had much apparent success. Despite regular downturns and financial crises, the wealth produced by our economies has grown and grown and grown. I think there’s a ready explanation that becomes visible through the conceptual lens of Ecological Economics, which tells us that energy isn’t a commodity like any other but a fundamental factor of production (part of a trio: matter, energy and human design intelligence). When your economy operates on an energy source that cranks out wealth-making value in a ratio of 100 to 1 or better—the estimated Energy Return on Energy Invested that petroleum offered us in the early 20th Century—you can believe any damn thing you want about how economies operate and your economy will still generate a great deal of wealth.

    Which is to say, high-EROI oil granted the new science of economics immunity from being proven false by events. But falsifiability of principles and propositions is one solid measure of a science. (Non-falsifiable beliefs are called faiths.)

    In effect the discipline of economics has a free rider problem—it’s been given a free pass by the enormous power of oil to misunderstand itself and its subject matter. You could also call it a Midas Problem, after the legendary king whose touch turned everything he touched into gold, including his dinner and his daughter. The power of wealth-generation that oil granted to our economy made it impossible for the discipline of economics to connect in any fundamental way with otherness, including the otherness of the planet and its role in the very processes that economics presumes to model.

    • Thanks for a very fine article explaining how neoclassical economists managed to go so far astray in their thinking, and then stay in this deluded state. These economists effectively assumed that all human activity consists of reversible processes, even though entropy makes this impossible. They completely missed the important role that oil and energy do. Their work is of course, completely non-reversible. As long as the economy was far from limits, false beliefs could go undetected. Once limits hit, this becomes clear.

      I apologize for Fast Eddy’s earlier remark. He clearly didn’t take time to read very much of the article. The dictation machine replaces some of the vowel-s combinations with â, (especially if there is an h before the vowel) making the article a big confusing if a person doesn’t take time to sit down to figure this out.

      I think the part that Fast Eddy objected to is the opening sentence:

      Ecological Economics and its corollary, Steady State Economic thinking, represent a step forward for the discipline of economics and also a return to how it was practiced in the past.”

      The statement, as you make it, is literally true. It did represent a step forward from where things were. The problem we face is that all improvements in academic thinking are incremental. I don’t think either Ecological Economics or Steady State Economics went far enough. Steady State Economics is particularly objectionable, because it seems to deny diminishing returns.

      In my article, I talk about a bread dough bowl that is already full, and we keep adding more. This is a point that gets missed. There is no way we can add even a little bit, but population keeps rising. A steady state doesn’t work, because it keeps using non-renewable resources. We are greatly overusing renewable resources right now. We don’t have a way of going forward, except perhaps at a very low level, such as hunter-gatherer, or subsistence level farmer. Even these would be available for a small share of the population. The idea that wind and solar can save us is a myth.

  6. Fast Eddy says:

    Excellent article!

    ‘Anyone who has watched bread rise in a bowl can see the implications of growth within a finite structure.’

    Bravo bravo!!!

    I suspect that if physicians looked at this patient… they’d be calling the morgue to reserve a space….

    • theblondbeast says:

      We’re in hospice – crank up the hopium.

    • jupiviv says:

      I agree FE, that is a excellent article. Here is another excellent quote from it you can marvel at and enjoy:

      “Neither climate change nor any of the other source-and-sink catastrophes facing civilization have been laid at the feet of bad economic theory. One reason: Neoclassical economists succeed in treating environmental costs as “externalities.” How could environmental degradation be the result of economic activity if it’s external to the economy?”

  7. Jarle says:

    Meanwhile in Norway: Almost 50 years since the discovery of our Ekofisk North Sea oil field. Not much discovered theses days and quite a few layoffs in recent years but unemployed rate is at a historic low level so according to the mainstream the future is bright.

    • doomphd says:

      careful about your government unemployment figures. per D. Orlov, in the US about 100 million (ca. 30% of population) potential workers are no longer seeking employment, being discouraged by the jobs outlook, and are thus not counted as “unemployed” by our BLS.

      Thanks for the new post, Gail!

  8. Alturium says:

    Hi Gail and fellow tverbergians!
    Great article! Question: for figure 2, how does applying a trend line to oil prices become a maximum affordable? How do you know the maximum affordable price, especially in a dynamic system? The max affordable may be a different plot than price history.

    Thanks!

    • Back in 2008, the maximum affordable was marked by the popping of the debt bubble. See my article https://ourfiniteworld.com/oil-supply-limits-and-the-continuing-financial-crisis/

      More recently, when prices stop rising, crude oil reservoirs seem to start filling. They reverse, when the price drops low enough so that supply rises and keeps supply in line with demand.

      At least over short periods, if there are not funny things going on with interest rates, the relationship seems to be linear. At least that is what technical analysis says. If is sort of like there is a price shock, and afterward prices bounce up and down like they might for aftershocks of an earthquake. The amount of bounce falls with time.

  9. Baby Doomer says:

    How Tesla Made a Record Profit

    The biggest boost to profits came from the sale of government credits, which Tesla earns by producing clean energy products like electric cars and can be sold to other companies to satisfy regulatory requirements. Tesla booked $189.5 million in credit revenue in the quarter, an unusually high result. Tesla had booked a total of about $135 million in the first two quarters of the year. These credits are almost pure profit for Tesla.

    https://www.wsj.com/articles/how-tesla-made-a-record-profit-1541436774?mod=e2tw

    • zenny says:

      Never trust the WSJ is telling the truth If you go with the opposite of what they say you will be in the pink.
      Not long ago they were pimping GE nothing but BS

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