More News on the Economy

I hate to be one of those snarky ‘I-told-you-so’ kind of people, but I did. I also explained why.

Now some of the mainstream economists (you know, the ones who are supposed to see these things coming) are thinking dismal thoughts as well. Welcome to the party gents.

Nouriel Roubini, who, to be fair, was one of the few who did see the 2007/08 debacle approaching before it actually arrived, has upgraded the chances of a “double-dip” recession to 40%. People tend to take notice when he speaks.

And then there is this from Robert Reich, Forget a Double-Dip, We're Still in One Long Big Dipper, who notes that the real problem is the joblessness that keeps consumers from buying goods and services. By the logic of economics, if consumers have income (jobs) they will buy and firms that make the stuff or provide the service will hire workers, and everybody will be happy again. And by classical Keynesian economic thinking, the government has to provide a jobs stimulus by spending money that will be used to jump start this process.

You know, I always considered Reich a very smart guy. I found his book, Supercapitalism to provide some very useful insights into how we got to where we are in the tradeoffs between democratic process, consumerism, and capitalism. In a nutshell, democracy loses out to our penchant to want the best prices for goods and services — and thus the WallMart effect — and to want to make money in markets, especially the housing and stock markets — the latter through the pressure that mutual fund managers and stock analysts bring on companies to keep their stock prices up at any cost. Enron ring any bells? We want low prices and high returns and this has led to corporate ascendancy over our democracy. Hence, lobbyists rule the Congress, and the people be damned. Reich nailed this, in my opinion.

But how he misses two extraordinarily important facts about the economy that completely demolish his arguments is a mystery to me. First, he is calling for a return to the consumer-based economy where jobs creation depends on everyone buying more stuff, creating a positive feedback loop that means perpetual growth. In other words, the business as usual scenario that created this messed up economy in the first place. The second fact of life is that the decline in net energy available to actually do the work of building stuff and providing services is working against everything. Energy (work) goes into everything we do. Less energy available over time means that we do less over time. There will be fewer goods and services and a lot less work (jobs) as a result. The only way this has been seemingly successfully thwarted to date is that jobs were shipped to low-energy consuming economies where corresponding wages were low, or by the importation of cheap labor (illegal aliens inherently consume less energy because they cannot demand higher wages to live the American dream).

This is actually pretty easy to see when you roughly compare worker lifestyles in various countries. Americans require higher wages to live their lifestyles because the sum of what they buy to support those lifestyles represents a significant amount of embodied energy. And since we know that money should be based on energy (actually exergy) we can see that wages will track the energy content of products and services. Currently, the average Chinese or Indian worker consumes much less and hence their embodied energy use is far lower and their wage requirements are lower. The costs to manufacture a ‘widget’ reflect the labor input and the amortized investment (in plant and equipment). The latter is lower in developing countries because much of the labor and materials that went into the plants came from local (low wage) sources. Consequently, it is no mystery why globalization has appeared to stave off the demon of inflation but at the cost of jobs for Americans. See Fig. 1 below.

This comparative advantage in labor can't last long, however. Even now some Chinese workers are becoming restless, wanting higher wages so they can buy more stuff. Once the consumerist lifestyle gets a toehold in a society the game is up. What we are witnessing is actually a consequence of the Second Law of Thermodynamics, in its entropy guise. We are seeing energy spread out, or diffuse from regions of higher potential (e.g. the US) to regions of lower potential (e.g. China) and eventually equilibrating. Everywhere will eventually have an equivalent energy density.

Figure 1. Why things cost more if made in America (or any OECD) vs. low energy consuming countries.

There are still many want-to-be-developing nations in the world where labor is going to be dirt cheap. As long as bunker oil doesn't get too expensive companies can always use container cargo ships to take the raw materials to where the labor is the best buy and haul the finished products to the consuming countries. However, there is a significant question as to whether corporations will have enough capital, or can borrow enough, to invest in new plants and equipment in some of these regions to take advantage of the cheap labor. And an even more significant question is who, among these consuming nations is actually going to be consuming (buying). China, maybe? How many customers that still have jobs will be able to take advantage of the cheap prices?

In truth there is no solution to this conundrum. Economies based on consumption and growth are doomed to failure because these two factors require increasing flows of net energy over time and on a global scale we will have less and less energy in the future. There will still be some shifting around for a while as energy supplies just manage to keep ahead of demand in different regions. But that won't be much longer. The end is in sight. The effects are already taking over in the US and other OECD countries that depend heavily on imported oil (Germany seems to be doing OK, marginally, but for how much longer?^*). Switching to coal (in the US) in those energy generation applications where it is actually feasible, or natural gas, may prolong the agony a bit longer. But it won't change the basic dynamic. The energy cost of obtaining the next unit of usable energy is steadily climbing. The BP debacle in the Gulf of Mexico will undoubtedly cause the costs of deep water drilling to go up and oil deposits in deep water is about all we have left to exploit (tar sands are every bit as expensive as deep water extraction).

I have yet to see one main stream economist, no matter of what school, point out the fundamental fallacies of our economic system. Not one. Most of these folks are not dumb but they sure are blind. They are blinded by their core ideology that sees growth of GDP as the solution to all problems. Even those few who are aware that there ‘might’ be an oil shortage problem believe that when the prices go up we'll switch to substitutes and get on with business as usual. We've always done that in the past so that is what we will do now.

You know, a minimum of two semesters of physics ought to be a requirement to major in economics.

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^* My gym buddy, Rudi, showed me an article from the New York Times, Saturday, entitled “Defying Others, Germany Finds Economic Success” by Nicholas Kulish. The author noted that the German people are still skitterish about their supposed success and maintain a very cautious, if not gloomy, outlook.

Comments

[barbara]

Good post -- I agree with what you wrote about energy and consumption. I see it happening here in the U.S. Throw in the rising populations of the world mix it with consumption and bake it with declining energy sources and you have a disastrous recipe. Let us promote an alternative system. -- barbara

[Molly Radke]

Excellent post, as usual....tho this chile doesn't see coal as much of an even temporary "solution" to the "energy problem." Sure, you'd get the additional coal based energy, but at the cost of intensifying global climate change, which is ALREADY wreaking havoc in many areas. From what I read elsewhere, the blind powers that be in this strange land are even now ramping up coal-based energy production. Alas for our kids and grandkids. Of course you're "right," as in "correct" - there's just no way outa this conundrum.

[David]

So how, in practice, would the economy work if we accepted the fact of no more economic growth?

Would it, dare I say, have to be similar to the command economies that have been tried in the past - only this time without the perceived success of free market capitalism over the border provoking envy and unrest in the population?

[PaulS]

One difficulty is that even a doctorate in physics wouldn't change much of anything. What you have to establish is not the silly tautology that growth to an infinite size is impossible. It's politically irrelevant, for example, that at current population growth rates, the Earth's entire surface will be covered by a seething mass of human flesh in seven or eight hundred years.

No, you have to establish that there is a serious constraint exerting itself, or that will do so within a time frame that people can grasp - i.e. 100 years out doesn't really count. The existence of such a constraint may be accepted in Peak Oil circles, but not in political circles. (And it's a bit risky to assert that no further technological progress will ever again be possible, an assertion that seems to be required to support some of the more doomish views in that community.) For that matter, I haven't even heard about any really serious constraint even from Steven Chu, who has more than two semesters of physics, although I certainly could have missed something.

[George Mobus]

Barbara,

An alternative system - yes. But what? Any thoughts?

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Molly,

Don't know if you've read any of John Michael Greer's stuff but he differentiates between 'problems', which can be solved, and 'predicaments', which cannot be solved, only bad consequences minimized (potentially). I concur with this characterization (in other circles predicaments are known as 'Wicked problems'). Our human condition is just such a case. We are in an unsolvable predicament and the sooner we recognize this and start looking for ways to minimize the bad consequences the better.

Of course one other characteristic of taking action in the case of predicaments is that of unintended consequences, or creating other predicaments as a result of those actions. You might lessen the pain in one domain only to increase it in another. I push the systems approach because I think it can help ferret out those potential consequences as you work through what actions might be taken. This is effectively what would be the ideal case in policy design, but, of course is almost never practiced.

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David,

I've actually written quite a lot about this question. You might be interested in some of those ideas. They can be found under the topics of "Sapient Governance" and "The Implications of a Sapient Governance" here: http://faculty.washington.edu/gmobus/Background/seriesIndex.html

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PaulS,

OTOH, aside from Secretary Chu, there have been a wide number of books by other experts (with more than two semesters of physics) that do or have pointed out the constraints.

Here is a very partial (and not up-to-date) bibliography that you might use to see this:
http://faculty.washington.edu/gmobus/TheoryOfSapience/globalIssuesBibliography.html

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George

[t0wnp1ann3r]

Help me work through this thought exercise:

Property is a tacit agreement amongst people that only one person has the right to use a specific area of land.

Money is in some way related to (and maybe more correctly should be directly related to) the use of energy, so that money flows in the opposite direction of energy... someone hands money over for oil, which has embedded energy.

If "debt" is really borrowing originally off of existing surpluses (the grain silo example)... then for whatever energy we're using now it already exists, and all "debt" is really the use of more energy than we actually need at this current moment to survive.

So if you think of "debt" not in the terms we usually think of it, but instead think of it as the use of currently surplus embedded energy (that really is just already existing on the planet as transformed sunlight)...

And then if you think therefore similar to property as being tacitly agreed upon left-alone land...

Then what "debt" really is, is actually existing surplus embedded energy already existing on the planet that a select group of people are using for their own desires while everyone else on the planet tacitly agrees that those people somehow have a right to that energy.

...because supposedly at some point in the future that select group of people will have lots of energy to bestow back upon the people who are voluntarily waiting for their chance at the energy trough.

And they're hoping that as they "develop," through increased esteem of the people currently allowed to use the excess embedded energy, that one day they too will be allowed to use some of the excess embedded energy.

And the reason everyone sticks to this tacit agreement that those specific people are allowed to use that land and use that energy, is because we still have these ideas in our heads that certain people are endowed with certain rights over other people... the same way people used to believe one race was better than another race.

So the only reason we don't have planet-wide revolution is because some people still believe that because of whom someone's parents were, that person is likewise entitled to use of excess energy that someone else wasn't because of who their parents were.

Well, there's that, and the energy embedded in the bullets that would be shot at those without as much energy, thereby keeping them in line, or rather out of line for feeding at the energy trough.

So, one way or another, because there is a finite amount of energy available on this planet and it is already spoken for by a minority, the approaching collapse will be a great equalizer.

The competition for energy will heat up as collapse gets closer, but at some point the EROEI of even these energy wars will eventually dissipate. There will be no energy left to fight each other over the energy that they no longer have the energy to extract.

How crazy does all this abstraction sound?

[George Mobus]

T0wnp1ann3r,

Crazy! Or maybe not.

I would like to suggest an alternative view of debt though. I recognize two kinds of true debt (and a third kind of pseudo-debt that is derived from these two). Probably the earliest kind was as you describe, borrowing from reserves to fund some current enterprise, as when a new farmer borrows grain (seed) from the granary to start a new farm. The granary contains an excess of grain needed for the current season because it is a form of insurance against future bad crop years.

Anyone who has borrowed against their life insurance policy goes into this kind of debt. Should they die, their beneficiaries get less payout.

The other kind is when we borrow against the future in the sense that we use not just insurance but also current needed wealth (e.g. our food grain) to fund an enterprise that we believe will pay back soon enough to cover the borrowed wealth and more, the profit.

The first kind is betting that you won't have a bad season (or die) before the payoff. The second is betting that your payoff will come soon enough that nobody will be short changed in the current period. This is embodied in fractional reserve banking, for instance.

There is, of course, a third kind that isn't really debt at all, but rather a bet on the above bets. It requires money that represents a claim on assets to work. We can, these days, through the so-called financial system, bet that debt-based bets will (or won't) pay off. These are the so-called derivatives. This kind of gamble has worked reasonably well as long as energy flow was growing because the greater energy flow meant more work would be accomplished in the future and the debts would come to be paid, unless one were completely foolish and failed at the enterprise.

Credit card debt strikes me as being of this latter type, especially if you have little or no savings. You are betting that you will have a job tomorrow. Under current circumstances, probably not a good bet.