Why Energy-Economy Models Produce Overly Optimistic Indications

I was asked to give a talk to a committee of actuaries who are concerned about modeling the financial future of programs, such as pension plans, given the energy problems that are often discussed. They (and the consultants that they hire) have been using an approach that puts problems far off into the future. I was trying to explain why the approach that they were using didn’t really make sense.

Below are the slides I used, and a little explanation. A PDF of my presentation can be downloaded at this link: The Mirror Image Problem.

Slide 1

FCAS stands for “Fellow of the Casualty Actuarial Society”; MAAA stands for “Member of the American Academy of Actuaries.” Actuaries tend not to be interested in academic degrees.

Slide 2

I try to explain how a more complex situation can be hidden in plain sight.

Slide 3

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Oops! The economy is like a self-driving car

Back in 1776, Adam Smith talked about the “invisible hand” of the economy. Investopedia explains how the invisible hand works as, “In a free market economy, self-interested individuals operate through a system of mutual interdependence to promote the general benefit of society at large.”

We talk and act today as if governments and economic policy are what make the economy behave as it does. Unfortunately, Adam Smith was right; there is an invisible hand guiding the economy. Today we know that there is a physics reason for why the economy acts as it does: the economy is a dissipative structure–something we will talk more about later.  First, let’s talk about how the economy really operates.

Our Economy Is Like a Self-Driving Car: Wages of Non-Elite Workers Are the Engine

Workers make goods and provide services. Non-elite workers–that is, workers without advanced education or supervisory responsibilities–play a special role, because there are so many of them. The economy can grow (just like a self-driving car can move forward) (1) if workers can make an increasing quantity of goods and services each year, and (2) if non-elite workers can afford to buy the goods that are being produced. If these workers find fewer jobs available, or if they don’t pay sufficiently well, it is as if the engine of the self-driving car is no longer working. The car could just as well fall apart into 1,000 pieces in the driveway.

If the wages of non-elite workers are too low, they cannot afford to pay very much in taxes, so governments are adversely affected. They also cannot afford to buy capital goods such as vehicles and homes. Thus, depressed wages of non-elite workers adversely affect both businesses and governments. If these non-elite workers are getting paid well, the “make/buy loop” is closed: the people whose labor creates fairly ordinary goods and services can also afford to buy those goods and services.

Recurring Needs of Car/Economy

The economy, like a car, has recurring needs, analogous to monthly lease payments, insurance payments, and maintenance costs. These would include payments for a variety of support services, including the following:

  • Government programs, including payments to the elderly and unemployed
  • Higher education programs
  • Healthcare

Needless to say, the above services tend to keep rising in cost, whether or not the wages of non-elite workers keep rising to keep up with these costs. Continue reading

The Physics of Energy and the Economy

I approach the subject of the physics of energy and the economy with some trepidation. An economy seems to be a dissipative system, but what does this really mean? There are not many people who understand dissipative systems, and very few who understand how an economy operates. The combination leads to an awfully lot of false beliefs about the energy needs of an economy.

The primary issue at hand is that, as a dissipative system, every economy has its own energy needs, just as every forest has its own energy needs (in terms of sunlight) and every plant and animal has its own energy needs, in one form or another. A hurricane is another dissipative system. It needs the energy it gets from warm ocean water. If it moves across land, it will soon weaken and die.

There is a fairly narrow range of acceptable energy levels–an animal without enough food weakens and is more likely to be eaten by a predator or to succumb to a disease. A plant without enough sunlight is likely to weaken and die.

In fact, the effects of not having enough energy flows may spread more widely than the individual plant or animal that weakens and dies. If the reason a plant dies is because the plant is part of a forest that over time has grown so dense that the plants in the understory cannot get enough light, then there may be a bigger problem. The dying plant material may accumulate to the point of encouraging forest fires. Such a forest fire may burn a fairly wide area of the forest. Thus, the indirect result may be to put to an end a portion of the forest ecosystem itself.

How should we expect an economy to behave over time? The pattern of energy dissipated over the life cycle of a dissipative system will vary, depending on the particular system. In the examples I gave, the pattern seems to somewhat follow what Ugo Bardi calls a Seneca Cliff.

Figure 1. Seneca Cliff by Ugo Bardi

Figure 1. Seneca Cliff by Ugo Bardi

The Seneca Cliff pattern is so-named because long ago, Lucius Seneca wrote:

It would be some consolation for the feebleness of our selves and our works if all things should perish as slowly as they come into being; but as it is, increases are of sluggish growth, but the way to ruin is rapid.

The Standard Wrong Belief about the Physics of Energy and the Economy

There is a standard wrong belief about the physics of energy and the economy; it is the belief we can somehow train the economy to get along without much energy. Continue reading

A new theory of energy and the economy – Part 1 – Generating economic growth

How does the economy really work? In my view, there are many erroneous theories in published literature. I have been investigating this topic and have come to the conclusion that both energy and debt play an extremely important role in an economic system. Once energy supply and other aspects of the economy start hitting diminishing returns, there is a serious chance that a debt implosion will bring the whole system down.

In this post, I will look at the first piece of this story, relating to how the economy is tied to energy, and how the leveraging impact of cheap energy creates economic growth. In order for economic growth to occur, the wages of workers need to go farther and farther in buying goods and services. Low-priced energy products are far more effective in producing this situation than high-priced energy products. Substituting high-priced energy products for low-priced energy products can be expected to lead to lower economic growth.

Trying to tackle this topic is a daunting task. The subject crosses many fields of study, including anthropology, ecology, systems analysis, economics, and physics of a thermodynamically open system. It also involves reaching limits in a finite world. Most researchers have tackled the subject without understanding the many issues involved. I hope my analysis can shed some light on the subject.

I plan to add related posts later.

An Overview of a Networked Economy

The economy is a networked system of customers, businesses, and governments. It is tied together by a financial system and by many laws and customs that have grown up over the years. I represent the economic network as a child’s toy made of sticks that connect together, but that can, if disturbed in the wrong way, collapse.

Figure 1. Dome constructed using Leonardo Sticks

Figure 1. Dome constructed using Leonardo Sticks

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