Should we return to a growth economy?

Krugman to the Rescue

First off, in fairness, we have to recognize that Paul Krugman is a liberal. His blog is called the Conscience of a Liberal, so I take him at his word.

I can understand his ideological stance with respect to wanting to relieve the American people who have lost their jobs and their homes. I can understand his railing at Tim Geithner (Treasury Secretary) and Ben Bernanke (Fed chairman) about the stupidity they are showing in not providing a stimulus to the economy that will relieve the pain and suffering (rather than a stimulus to the bankers and Wall Street to help their managers earn even bigger bonuses). Krugman has heart, I'll give him that. But here is what being stuck in a liberal ideology gets you: This Is Not a Recovery, 26 Aug. 2010. The remedy, for Krugman and every other neoclassical economist is growth.

I'm afraid I have to say, for one of the smartest economists in the world he sure is dumb!

He gets that the so-called economic recovery is a sham. He gets that what the government is doing is appallingly weak compared to what it should be doing under historically relevant conditions to truly stimulate the economy to produce jobs and get people back to work. What he doesn't understand is that these are not historically relevant times. This isn't the same situation as existed in 1932. What he s proposing is exactly the wrong thing to do if you care about the long-term. He wants to return to a growth economy based on consumer spending^*. The pain he wants to relieve includes that which the American public is suffering not being able to go to Wallmart and shop to their hearts' content.

What, oh what, will it take to get people like Krugman to see reality? This question is especially cogent since reality is slapping us all in the face. You would think that Nobel Prize winners would be able to know when they are being slapped in the face and wake up to see that reality. “Thanks, I needed that.”

George, Get With the Program Man

No doubt if we did get back to a growth economy, in the range of 5+% annual, that this would help create more jobs and drive the unemployment numbers down. That has been the historical case. But exactly what is going to be growing? In other words, what in the economy would be able to grow to make the GDP grow by 5% a year? Would it be primary manufacturing? Not likely. Labor in China is still a lot cheaper than it is here, for the moment. Extractive industries? Maybe coal, but most of our mining operations are worked out. Retail maybe? If we could get cash into everyone's hands they would go buy more stuff and that would boost the retail industry. But wait a bit, many people today are going to pay down their debt from past shopping extravaganzas, many will divert the cash to savings. Services then? We have to ask what kind of services? Flipping burgers, that's a service. But the fast food business is just another form of retailing. How about beauty parlors, maybe we could treble the number of chairs and hair dressers. That is a needed service.

Wait, there is a service area that could easily expand and create some really high paying jobs — the financial services area! It is simple. The government lets the banks and Wall Streeters create many more creative financial instruments and sell them to ‘investors’. They will literally create more money, more value, and more transactions. That will look good in GDP numbers. If we were to completely kill all financial sector rules and regulations the GDP would soar and a significant number of financial service workers would then get rich. Here is the best of all. They need to buy hamburgers, get hairdos, and buy lots of expensive stuff. Thus retail and the rest of the service sector will expand once again. And when it does somebody has to raise or import the beef, shampoos, and fancy cars. Boy, this is sounding better all the time.

All we need to do, and I bet anything Tim Geithner already knew this, is we let the financial movers and shakers go to town and everything will be hunkydory once again. The recovery will be complete. We will be growing once again. Surely this last little hiccup in the economy due to financial (including mortgages) bubbles won't happen again. The free market will prevail.

Economic Growth Solves All Problems

Actually it does seem to do so as long as you look past real human happiness and measure problems solved in materialist terms (like GDP). It has been the case in the past and why would we think there is any reason why it wouldn't work that way now? Well one comes to mind: We've reached the limits of energy and material resources and you can't grow beyond those limits. I has turned out that the physical limits of our world really do define a fixed size pie that has to be sliced into thiner and thiner pieces if everyone is to get some (oh yeah, some don't so that others can get bigger pieces).

Our whole understanding of what the economy is, how it works, and what it takes to give a majority of folk a shot at living reasonably comfortable lives is bound up in a system that is always growing. We simply cannot conceive of any other way to organize things. People need jobs to earn incomes. Those incomes have to be sufficient to pay for necessities of life and some discretionary goods and services so as to have some enjoyment in life. Jobs come from firms constantly needing labor and management to produce goods and services on a continuous basis. The latter is supported by customers in sufficient numbers to put a continuous demand on the firms. Where do customers come from? Well, we need to have more people needing the goods and services; the customer base has to expand (births plus immigration). We can also build shoddy stuff that falls apart after awhile so that the customers need to continue to replace them. Or design new models that make the old models so obsolete that customers are embarrassed to be caught with the old models (Apple comes to mind).

Ah, but when the customer base is growing that means there are also more people needing more jobs. So we have to grow firms so as to meet the demand and create jobs. Why does this look like a vicious cycle to me?

Its a positive feedback loop that perpetuates the need for more jobs, stuff, and people (consumers and workers). And all positive feedback loops, if they predominate in any system, will lead to an eventual blowup. Unless, of course, the expanding system runs into resource constraints which is exactly what is happening today.

At our present rate of consumption (world wide) we are reaching the ends of economically extractable energy and material resources. We are even depleting our potable water supplies! How do you deplete a completely recyclable resource? We managed it. These limits are going to be felt most painfully in the depletion of fossil fuel energy sources. At least if we had more energy we could find ways to solve material resource depletion. We could find ways to recycle and substitute for quite a while longer. But the truth is that once fossil fuels start be take more energy to extract than they provide for other economic work we will have hit the wall.

Actually it is already underway. You can point your finger at the financial meltdown, the housing meltdown, the jobs meltdown or any number of proximal causes for the global economic recession (everywhere except China, for the moment). But there really is a single underlying cause of all the problems that we have great difficulty recognizing because we've always had the luxury of taking it for granted. Net energy is now in decline. And it takes net energy to run the economy, even if it weren't growing.

A growing economy requires a growing flow of net energy into the system. That means we have to find and extract much more fossil fuel each year than the year before. And we have to extract so much more that we can pay back the increasing energy costs of doing that extraction. We haven't been doing this. The peak of oil extraction marks the start of decline in total energy extraction. But more importantly, the peak of net energy came many years ago, before the peak of fossil fuel. This is because the energy costs of extraction have been increasing (exponentially, actually) leading to declining net profit to apply to other economic work.

We are no longer in a growth economy because we are no longer in a growing net energy environment. We aren't even in a steady state net energy flow so the potential to construct a steady state economy is no longer an option. Put rather rudely, we are now in a contracting economy, and will be for as long as we care to consider. There will be no new jobs created because there will be decreasing energy available to do the work. The so-called “knowledge-based” economy is an illusion. It is true that we need and use knowledge to run the economy, but the only real base of any economy is the food we produce to keep ourselves alive, followed by the construction of goods that support our living in temperate and cooler climates. And all of those base activities require a lot of energy. Knowledge isn't worth a dime if you can't eat it, or live in it.

The longer Krugman and Geithner and Obama and every one is committed to the notion that the only way out of our situation is to recover the consumption/growth economy the worse we are going to find ourselves when it finally becomes so obvious what is happening that even these geniuses finally get it. Then it will be too late to try to adapt and reconstruct an economic model based on biophysical realities instead of one based on so-called American dreams. You can't dream yourself satiated, unless you're in delirium from starvation!

 

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^* One alternative to the consumer-based economy is the export economy. We would presumably make our money by providing some kind of needed goods or services to the rest of the world. We would need some kind of competitive advantage. Some economists think that our knowledge-workers will provide knowledge services to other places in the world. A little reflection on this idea will soon turn up any number of reasons why it is stupid, not the least of which is that other countries are rapidly developing their own knowledge workers. Besides, the geniuses are still thinking that growth in sales (of exported somethings) is a necessary part of the scheme.

Comments

[Sublime Oblivion]

A very good exposition on why the Krugman mantra of more and more stimulus will be as stillborn as the Tea Party dogma that growth will resume as soon as the guvmint gets off our backs. It's all in the exergy trends...

I wrote on the matter a week ago here: "Another View of the US Economy: Observations on Exergy, GDP & Median Incomes".

[Robin Datta]

"Should we return to a growth economy?"

That such a question even has to be posed at this advanced stage is an indication of how shabby the state of understanding is.

"What he doesn't understand is that these are not historically relevant times."

When one's livelihood and lifestyle depends on sustaining the paradigm that one operates in, that person will naturally defend that paradigm to even to the extent of a subconscious mental blockade of all threatening alternatives.

And unfortunately, the folks in the uppermost echelons of power, influence and wealth are the last ones to be significantly affected by the physical changes in the paradigm shift. They can therefore continue their charade the longest.

[Sam]

George,
Some good points, but I have felt that with some of your posts on the economy, you haven't been sufficiently nuanced. For instance, in this post, while you credit Krugman with criticizing Geithner and Bernanke for their inability to realize what's going on, you then lead into a rant about the financial services industry, and how it will prop up temporary growth without producing anything tangible. Not only has Krugman been prominent in criticizing Geithner for his failed handling of the economy, but he has also been most vociferous in his critique of the economic elite for their defense of the financial services industry, which as both of you note, doesn't produce any useful good or service. http://www.nytimes.com/2010/04/23/opinion/23krugman.html But the way you write this makes it sound as if Krugman is endorsing a return to the metastasizing growth of the financial service industry, which he would vigorously deny. There is a place for banking institutions in an economy, but it is a much smaller one than currently exists in the U.S. economy, and I think you both would agree on that point.

You are most right to criticize Krugman for his defense of growth, but in fact, he does tend towards some of your positions, whether it is on shrinking the financial services sector, or expanding the government (via the stimulus) to make future investments in energy and environmental sustainability . (I imagine that had it been proposed by Obama, your soil conservation corps idea would have received Krugman's support. I also recognize that there is a debate to be had about how much these investments will actually do to prolong society as we know it, but I hope you can agree that these investments are at least better than tax cuts to promote consumer spending, which is the sad alternative proposed by many economists other than Krugman). Your critique of neoclassical economics with biophysical economics is perfectly valid and I couldn't agree more, but I would just be careful when lumping Krugman and other "liberal" economists (inc. Stiglitz) with the rest.

Also, in a future post, a defense of why market economics is inappropriate for pricing biophysical resource constraints would be appropriate. The neoclassical economists often argue that if a resource becomes limited, its price will adjust in the marketplace and consumers will search for substitutes. So what if we run out of oil? There's plenty of wind and solar. And that knowledge-based economy you criticize will come into fruition when the market for energy-saving devices/software and energy efficiency consultants heats up as energy prices rise. And once automakers see that people want their cars powered with electricity rather than petroleum because of energy costs, they'll start making electric cars like crazy. Admittedly, I am a bit facetious when writing this and there are many ways you can knock down this argument. But I don't feel your critique of neoclassical economics is complete until you fully explain why the market mechanisms promoted by traditional economists cannot handle the biophysical realities we face.

[Pangolin]

What concerns me is that at the same time energy constraints are squeezing down economic participation climate change effects are destroying segments of the global economy.

Every time we get and event like Pakistan, Moscow or Nashville whatever chunk of the worlds productive ability that was in the way is out of action. The nasty trick is that we still need to produce food, shelter and services for the humans because they tend to get out of the way.

Where is the inflection point where it becomes obvious to the common person that we can't keep up?

[George Mobus]

Sublime,

Thanks for bringing this to our attention. I took a quick look and will get back to it.

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Robin,

Perhaps we should keep an eye on the angry crowds and their proximity to the Hamptons (or gated communities)!

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Sam,

The problem with blogs is that you can get in a hurry and not get your ideas across as well as you should! I apologize for making it sound like Krugman favored the financial sector. I brought that up in a sarcastic (I thought) way to show 1) that there really isn't any other sector of the economy that is primed to grow; and 2) that the only way we have managed to appear to be growing and creating so many service sector jobs in the past is by having a non-producing financial sector as it has been played in the recent past. In other words, I was trying to say that the only way we can return to growth is to let the financial guys go at it again. My footnote on the potential of export growth being the basis of a growing economy in the future, something I believe Krugman has supported, should have been made more prominent perhaps to emphasize that there just aren't any viable economic sectors that can grow other than the phony creation of wealth in derivatives and bubble markets.

I will try to be more careful in the future as you suggest. Sometimes my incredulity at many of these high-profile economists and talking heads not recognizing that we live in a changed world gets the better of me.

I have actually written a bit on market mechanisms in the past, particularly as one of the mechanisms in operational control in a hierarchical control theory of societal organization -- sapient governance. But it would be possible to break it out and make it more explicit in terms of economics per se. I will think a bit more on how to approach it.

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Pangolin,

I too worry about the fact that just when we will need lots of energy to adapt to climate change, we will be on the skids. As for when the common person will be able to recognize it, that is anybody's guess. Personally, I suspect the answer is 'never, until it is too late'. The insurance companies have already started to take notice though.

George

[Phil Henshaw]

George, your premise seems to be that we don't have a growth economy if growth does not happen to materialize. Is that true?

[George Mobus]

Phil,

I'm afraid I don't understand the question! My premise is that growth depends on an increase in net energy flow over time. The only way we can appear to have a growth economy, as defined by increase in GDP, is by faking it with pseudo-wealth financial instruments that create the illusion of wealth increase when, in fact, our real wealth is already in decline.

I can't understand this phrase: "...if growth does not happen to materialize." I hope I didn't say anything like that!

George

[CASSE]

Readers can help jumpstart the transition to a steady state economy by signing the CASSE position on economic growth (www.steadystate.org).

Brian Czech, President
Center for the Advancement of the Steady State Economy

[Curt]

I find that I agree with a vast majority of the concepts you discuss - overshoot, the ultimate depletion of fossil fuels, the coming bottleneck, etc. I agree that energy has fundamentally driven growth in the past, and will need to in the future. So I find myself hypothesizing about ways to improving our energy stature near term. What if we made vast improvements in the energy grid of this country and worked to provide virtually 100% of our electricity with nuclear power. Fossil fuels could then be directed toward a smaller set of needs that are not easily replaced/substituted by electricity. Think of the engineering/construction effort needed to achieve this goal. Real jobs - moving dirt, making things, swinging hammers - the kind that would truly feed an economic recovery. I realize nuclear is not everyone's favorite. But there are alot of new designs on the horizon, requiring significantly less capital input to build. America has demostrated technological superiority in it's first couple hundred years. We need to be working toward rekindling a similar effort. An economy based once again on the making of widgets has the potential to secure the best possible future for what remains ahead for the human race. When the situation gets grave enough, interesting technological questions will need to be addressed. I only hope it's not too late once we get there.

[genes]

George,

I've read several times in your blog that net energy is already in decline. Can you direct me to a link for your calculations on this? I teach a course in environmental science with a large energy component, and would like to show a nice graph of net energy trends over recent years. Thanks for any info...

[George Mobus]

Curt,

I don't know anyone who is not hopeful that there is some feasible solution to our energy crises. Daily I pour over one or more analyses of energy systems, extraction, generation, distribution, and uses. The science and engineering communities where these analyses come from have slowly come to the conclusion (or are starting to converge on it) that given the scale of the problem of generating enough electricity, even after our society might have minimized its wastefulness, and given the time frame in which a wholesale conversion from fossil fuels would need to be done in order to not cause massive dislocations, and given the state of the technology, i.e. generally low EROIs, especially when intermittency is considered, there is simply no formula that produces a viable scenario.

The more likely situation is that we will be in a contracting economy for long into the foreseeable future and the sooner we realize this and accept it as inevitable the sooner we can get to work determining what that economy looks like and start implementing realistic actions that will minimize suffering. Our continued denial of what that future looks like by holding out hope for technological solutions is just postponing the inevitable which will translate into more suffering than might have been necessary.

George

[George Mobus]

Genes,

Here is the URL to a pre-publication summary of the work:
http://questioneverything.typepad.com/question_everything/2009/12/economic-dynamics-and-the-real-danger.html

Note that the paper has not yet gone through peer review so it may not stand up in court, as they say. You should probably use it with caution.

Here is a link to David Murphy's Net Hubbert paper:
http://netenergy.theoildrum.com/node/5500

Dave and I used different starting places and assumptions/method, but both reached similar conclusions about the nature of net energy relative to peak oil.

Hope this helps.

George

[Tax Lawyer]

First, we need a massive redistribution of wealth before growth can occur. If everyone is saving and buying bonds, gold and other non-productive assets, then economic growth will decline even faster than you predict. Politically, I don't see this happening until the legislature is scared about what the masses will do, since they are so captured by the financial and multinational interests. Like the initiation of the New Deal, this won't happen without a real threat to the status quo. The only reason the New Deal happened was the potentially real threat to capitalism that communism would bring.

Second, once wealth is redistributed, investment will begin to move from non-productive assets to productive ones. I still have a bias in favor of innovation.

Do you think we are about to slide into a permanent Malthusian second Dark Age?

Eventually, the masses will not permit the top 1-5% to own 70% of the wealth in this country. As to the energy question, so long as fossil fuels are cheaper than alternatives, they will predominate and growth will remain stuck. Little concentrated effort will go into alternative energy. We need something similar to the Space Program, or the massive increase in the defense budget focused on alternative energy--but the multinationals will not permit it.

Finally, in a zero-sum game, if we allow such massive offshoring of jobs without penalty, due to the multinationals and their shareholders literally owning Congress, we are doomed. When will the tariffs of the 1800's return?