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When Scientists do economics

Volume one of Das Kapital was the final work produced by Karl Marx.  Volumes two and three were completed by Friedrich Engels from Marx’s notes.  According to the Grundrisse – literally the “blueprint” – Marx had intended to produce ten volumes that would describe how the industrial economy worked.

The interesting biographical point here is that Marx never set out to be an economist.  Like the majority of people then and now, Marx began with the belief that economists could be trusted.  Classical economic theories developed from the writings of luminaries like Adam Smith and David Ricardo could be assumed to be correct because they would have to stand up to the scrutiny of peer review.

Only later did Marx come to realise that economists simply make stuff up to paper over their ignorance.  And even when economic theories are demonstrably disproved by events, economists refuse to amend or dispense with their failed models.  If the world will not conform to econometrics, the world can go hang.

The only option open to Marx – whose goal, remember, was not simply to understand the world; but to change it – was to learn economics for himself in order to rewrite it in a way that conformed to the world around him.

The economic theory that Marx eventually developed was fundamentally flawed – although that might be forgiven to some extent by the state of geological and biochemical science at the time.  Nevertheless, Marx provided insights that are still relevant today; most notably the concept of cyclical “crises of over-production” in which, if the wages share of profits falls too low, working people (collectively) cannot afford to buy back the (collective) fruits of their labour… in reality, then, a “crisis of under-consumption.

In feeling obliged to enter the field of economics in order to correct its obvious defects, Marx was merely marking out a path that many others would follow in due course; and for the same reason.  The industrial economy does, indeed, have a broadly cyclical nature.  Rather, it consists of several cycles that sometimes amplify and sometimes diminish one another.  The outcome is that since the turn of the nineteenth century we (in developed economies) enjoy periods of prosperity punctuated by crises of varying magnitudes that result in periods of stagnation or depression.  It is, of course, in the wake of these crises – particularly the larger ones – that academics schooled in other disciplines turn to the economists and ask – to quote the current Queen of England – “Why did nobody see this coming?”

The answer, of course, is that economics is no more a predictive science than is astrology or homeopathy.  As another soul who followed the path laid down by Marx was to observe:

“All the requirements of pre-scientific men were met out of the solar energy of their own times. The food they ate, the clothes they wore, and the wood they burnt could be envisaged, as regards the energy content which gives them use-value, as stores of sunlight. But in burning coal one releases a store of sunshine that reached the earth millions of years ago. In so far as it can be used for the purposes of life, the scale of living may be, to almost any necessary extent, augmented, devotion to the primitive ideas of the peoples of Kirkcaldy and Judea notwithstanding.”

By the “peoples of Kirkcaldy,” English Nobel Prize winning chemist and reluctant economist Frederick Soddy is referring to Adam Smith (who lived in Kirkcaldy) and the classical liberal economists.  The “primitive ideas” he is equating them with are the Abrahamic religions that arose from people who spent a little too much time baking their heads in the deserts of the Middle East.  That is, Soddy is dismissing economics as a religion.

Soddy’s Wealth and Debt: The Solution of the Economic Paradox was written in the wake of the 1929 Wall Street Crash – at that time, the biggest economic shock the industrialised world had endured.  And like Marx, Soddy was critical of economists’ tendency to make stuff up and then to ignore demonstrable instances when the real world proves their theories wrong.

Soddy goes on to establish a foundation for the modern energy economics that is beginning to emerge from the work of contrarian economists like Steve Keen.  As Soddy observes:

“Still one point seemed lacking to account for the phenomenal outburst of activity that followed in the Western world the invention of the steam engine, for it could not be ascribed simply to the substitution of inanimate energy for animal labour. The ancients used the wind in navigation and drew upon water-power in rudimentary ways. The profound change that then occurred seemed to be rather due to the fact that, for the first time in history, men began to tap a large capital store of energy and ceased to be entirely dependent on the revenue of sunshine…

“Then came the odd thought about fuel considered as a capital store, out of the consumption of which our whole civilisation, in so far as it is modern, has been built. You cannot burn it and still have it, and once burnt there is no way, thermodynamically, of extracting perennial interest from it. Such mysteries are among the inexorable laws of economics rather than of physics. With the doctrine of evolution, the real Adam turns out to have been an animal, and with the doctrine of energy the real capitalist proves to be a plant. The flamboyant era through which we have been passing is due not to our own merits, but to our having inherited accumulations of solar energy from the carboniferous era, so that life for once has been able to live beyond its income. Had it but known it, it might have been a merrier age!”

This was the piece of the scientific jigsaw that had not been available to Marx when he was struggling with his version of David Ricardo’s “Labour Theory of Value.”  The coal that provided the once-and-for-good fuel for industrialisation was fossilised plants; plants that – collectively – contained a massive store of hydrocarbons.  Marx had glimpsed this briefly in the grundrisse when he admitted that mechanisation could also (alongside labour) be a source of value.  In this, he was mistaken, of course.  The machine was merely harnessing the true source of value – the millions of years of sunlight fossilised into coal.

Soddy was able to see this far more clearly.  And from this, he was able to explain the schizophrenia that separates the supposedly infinite world of banking and finance from the finite energetic world of what we might today call the “real economy”:

“It is natural for the ordinary man, to whom money or any similar title to wealth is, normally, completely equivalent to real wealth, to consider money as wealth. For the law, which is concerned with government, to remain merely a reflection of earlier and more primitive ways of living is a serious offset against the social value of scientific knowledge.

“As for economists, they have made spasmodic efforts to rid their systems of these confusions, it must be admitted with some success, until the rapid developments in modern finance and banking and the changes that have come over the very nature of money in recent years brought back again the demons they had partly exorcised in seven-fold greater force.”

Compare Soddy writing in the early 1930s to Steve Keen’s criticisms of modern economics in the wake of the 2008 crash:

“It may astonish non-economists to learn that conventionally trained economists ignore the role of credit and private debt in the economy – and frankly, it is astonishing.  But it is the truth.  Even today, only a handful of the most rebellious of mainstream ‘neoclassical’ economists – people like Joe Stiglitz and Paul Krugman – pay any attention to the role of private debt in the economy, and even they do so from the perspective of an economic theory in which money and debt play no intrinsic role.  An economic theory that ignores the role of money and debt in a market economy cannot possibly make sense of the complex, monetary, credit-based economy in which we live.  Yet that is the theory that has dominated economics for the last half-century.”

Soddy’s conclusion was simple enough.  If governments, bankers and financiers did not bring the money supply (which economists wilfully misunderstood) into line with the energy available to the economy, then energy shortages would do it in a far more chaotic way on their behalf.  It is worth, perhaps, at this point outlining the broad sequence of events that lead into economic crises to make the point:

  1. Energy supplies cannot keep pace with growing demand generated by excess currency creation (because banks lend into economic upswings)
  2. Energy prices increase causing price rises throughout the economy
  3. Central banks respond by raising interest rates and governments respond by cutting public spending
  4. Ordinary people faced by rising prices, rising debt-servicing costs and falling pensions, benefits and services can no longer afford to consume and begin to default
  5. banks curtail their lending and people attempt to pay off outstanding debt; removing yet more currency from the economy
  6. Firms are plunged into a crisis of under-consumption that results in bankruptcies that exacerbate the crisis
  7. Eventually bank assets and government bonds are dramatically devalued as their value is realigned with the energy available to the economy
  8. After a period of depression (in previous cycles) new sources of energy are tapped into, allowing the economy to grow once more.

The alternative to this form of crisis is for governments and central banks to, as it were, cut out the middle-man and jump straight into monetary devaluation and wealth destruction by simply inflating the debt away via increased currency printing.  Both approaches arrive at the same destination.

In recent years, more scientists have followed Soddy along Marx’s path to rewriting economics in a form that conforms with the real world.  Charles A.S. Hall, a professor of biology who applied the optimal foraging theory of fish behaviour to the energetic nature of the real economy, and who founded the school of ecological economics is famously dismissive of contemporary economic theory:

“If one of my graduate students presented me with this (neoclassical economic theory) I would give it an A+ for imagination and an F- for its lack of grounding in reality.”

Like Soddy before him, Hall sees energy as the driving – and limiting – factor behind the industrial economy.  Hall goes much further, however, by beginning to quantify the energetic constraints facing the industrial economy.  In studying fish, Hall demonstrated that each fish – and, indeed, any organism – must obtain more energy than it requires to maintain itself.  Failure to do so will prevent the fish from hunting, migrating and reproducing in future.

Applied to an industrial economy, Hall arrived at the concept of energy return on energy investment – EROI.  A proportion of the energy available to any economy must be invested in securing useable energy for the future.  How much energy?  That depends upon how easy or difficult the resource is to obtain and deliver.  The EROI of US oil in the 1920s was around 100:1.  That is, for every barrel of oil equivalent energy invested in the oil recovery industry, 100 new barrels of oil were returned.

The problem, of course, is that humanity has harvested fossil fuels on a “low-hanging fruit-first” basis.  By the 1970s, the EROI of the oil and gas being pumped out of the North Sea and the Gulf of Mexico had fallen to perhaps 25:1 – still a huge return; although one that rules out our ever returning to the spectacular rates of growth enjoyed in the magic two decade long boom 1953-1973.

Contemporary “unconventional” liquid fuels, such as those from hydraulically fractured shale deposits or from mined bitumen sands have a significantly lower EROI; while the EROI of corn-based ethanol is actually negative – like hydrogen, it returns less energy than it takes to produce.  For Hall, this is a problem because various elements of the industrial economy that we have come to take for granted require a relatively high EROI to sustain.  Hall provides an EROI hierarchy that estimates the point at which various systems break down:

Hall's EROI hierarchy

As we fall back on fossil fuels (which continue to provide more than 80 percent of our energy) with an EROI of 5:1 or less, we begin to see that over-extended debt loads in the banking and financial sector might be the least of our worries.  As an increasing proportion of our energy has to be devoted to securing energy for the future, the amount of surplus energy left over for the wider economy is shrinking.  This process is inevitably undermining the contemporary forms of essentials like healthcare and education which developed in periods when energy was cheap and abundant.

Like Hall, French Professor of Engineering Jean-Marc Jancovici has been obliged to school economists and politicians on the harsh realities of energy economics.  For Jancovici, the single most important take away is that the volume of energy per capita is the determining factor in the economy.  Forget price.  Economists are simply wrong to believe that as the price of energy increases, so too will its supply.  That is not how the energetic economy operates:

Modern Economics: Goldilocks is dead

Of course, as Soddy noted back in the 1930s, so long as the planet was awash with cheap and abundant energy, economists could make up any theory they liked in order to justify the social hierarchy that afforded them their income and status.  Jancovici points out that those days are long gone for two clear reasons.  First, we cannot produce the high energy returns that we built our industrial economy upon.  Second, any attempt to do so is likely to destroy the habitat that we depend upon.  As Jancovici points out, even the so-called “circular economy” on which many now pin their hopes for the future of industrial civilisation must continue to add energy to the system in order to recycle and recirculate the resources that it requires.

This hard science is almost entirely ignored in the rarefied halls of economics.  Instead, the belief that infinite growth on a finite planet is a reasonable goal remains.  As another scientist, US Physicist Tom Murphy, relates in a dinner party conversation with an economics professor:

“Economist: [chokes on bread crumb] Did I hear you right? Did you say that growth cannot continue forever?

“Physicist: That’s right. I think physical limits assert themselves.

“Economist: Well sure, nothing truly lasts forever. The sun, for instance, will not burn forever. On the billions-of-years timescale, things come to an end.

“Physicist: Granted, but I’m talking about a more immediate timescale, here on Earth. Earth’s physical resources—particularly energy—are limited and may prohibit continued growth within centuries, or possibly much shorter depending on the choices we make. There are thermodynamic issues as well.”

Murphy goes on to explain that – climate change aside – if we continue to grow our per capita energy consumption at the rate we have been doing since the 1650s, the waste heat that we generate will raise the global temperature to boiling point in about 400 years.  With greenhouse gases taken into account, things are going to get pretty unpleasant in a much shorter time frame of course.  Although our inability to keep adding to our energy production may at least invalidate the worst climate change projections.

Steve Keen, one of the few economists to accurately predict the 2008 crash through his use of modelling that paid regard to the role of money and debt, is one of the few to understand the importance of energy to the economy.  As Keen puts it:

“Capital without energy is a statue, labour without energy is a corpse.”

Keen, however, stops short of examining the consequence of falling per capita energy volumes to the industrial economy.  The continuous flows of energy from fossil fuels can, according to Keen, be replaced by technologies that will harness renewable energy sources like sunlight, wind and tides.  In this respect, Keen is travelling the road laid down by Marx and followed by scientists like Soddy, Hall, Jancovici and Murphy, but it the opposite direction.  Because it turns out that economists are not the only people who make stuff up in order to justify their next pay check.  So-called “green energy” technology designers from Saint Elon himself all the way to the inventors of solar roadways and the self-filling water bottle turn out to be even bigger charlatans than economists.

The science, however, is clear.  As the flow of per capita energy available to the economy decreases, so too will our economic activity.  Whether we borrow or print an additional trillion or gazillion units of new currency is irrelevant to this hard fact.  We can – like economists – simply demand that the real world bend to our will; or we can acknowledge our limits and change our way of life accordingly.  Either way, change we will.

As you made it to the end…

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