Welcome to the age of diminishing returns

Friday, November 25, 2011

Why is economic growth so popular?


When the new Italian Prime Minister, Mr. Mario Monti, gave his acceptance speech to the Senate, a few days ago, he used 28 times the term "growth" and not even once terms such as "natural resources" or "energy". He is not alone in neglecting the physical basis of the world's economy: the chorus of economic pundits everywhere in the world is all revolving around this magic world, "growth".  But why? What is that makes this single parameter so special and so beloved?


During the past few years, the financial system gave to the world a clear signal when the prices of all natural commodities spiked up to levels never seen before. If prices are high, then there is a supply problem. Since most of the commodities we use are non-renewable - crude oil, for instance - it is at least reasonable to suppose that we have a depletion problem. Yet, the reaction of leaders, decision makers, and economic pundits of all kinds was - and still is - to ignore the physical basis of the economic system and promote economic growth as the solution to all our problems; the more, the better. But, if depletion is the real problem, it should be obvious that growth can only make it worse. After all, if we grow we consume more resources and that will accelerate depletion. So, why are our leaders so fixated on growth? Can't they understand that it is a colossal mistake? Are they stupid or what?

Things are not so simple, as usual. One of the most common mistakes that we can make in life is to assume that people who don't agree with our ideas are stupid. No, there holds the rule that for everything that exists, there is a reason. So, there has to be a reason why growth is touted as the universal cure for all problems. And, if we go in depth into the matter, we may find the reason in the fact that people (leaders as well as everybody else) tend to privilege short term gains to long term ones. Let me try to explain.

Let's start with observing that the world's economy is an immense, multiple-path reaction driven by the thermodynamic potentials of the natural resources it uses. Mainly, these resources are non-renewable fossil fuels that we burn in order to power the whole system. We have good models that describe the process; the earliest ones go back to the 1970s with the first version of "The Limits to Growth" study. These models are based on the method known as "system dynamics" and consider highly aggregated stocks of resources (that is, averaged over many different kinds). Already in 1972, the models showed that the gradual depletion of high grade ores and the increase of persistent pollution would cause the economy to stop growing and then decline; most likely during the first decades of the 21st century. Later studies of the same kind generated similar results. The present crisis seems to vindicate these predictions.

So, these models tell us that depletion and pollution are at the root of the problems we have, but they tell us little about the financial turmoil that we are seeing. They don't contain a stock called "money" and they make no attempt to describe how the crisis will affect different regions of the world and different social categories. Given the nature of the problem, that is the only possible choice to make modelling manageable, but it is also a limitation. The models can't tell us, for instance, how policy makers should act in order to avoid the bankruptcy of entire states. However, the models can be understood in the context of the forces that move the system. The fact that the world's economic system is complex doesn't mean that it doesn't follow the laws of physics. On the contrary, it is by looking at these laws that we can gain insight on what's happening and how we could act on the system.

There are good reasons based in thermodynamics that cause economies to consume resources at the fastest possible rate and at the highest possible efficiency (see this paper by Arto Annila and Stanley Salthe). So, the industrial system will try to exploit first the resources which provide the largest return. For energy producing resources (such as crude oil) the return can be measured in terms of energy return for energy invested (EROEI). Actually, decisions within the system are taken not in terms of energy but in terms of monetary profit, but the two concepts can be considered to coincide as a first approximation. Now, what happens as non-renewable resources are consumed is that the EROEI of what is left dwindles and the system becomes less efficient; that is, profits go down. The economy tends to shrink while the system tries to concentrate the flow of resources where they can be processed at the highest degree of efficiency and provide the highest profits; something that usually is related to economies of scale. In practice, the contraction of the economy is not the same everywhere: peripheral sections of the system, both in geographical and social terms, cannot process resources with sufficient efficiency; they tend to be cut off from the resource flow, shrink, and eventually disappear. An economic system facing a reduction in the inflow of natural resources is like a man dying of cold: extremities are the first to freeze and die off.

Then, what's the role of the financial system - aka, simply "money"? Money is not a physical entity, it is not a natural resource. It has, however, a fundamental role in the system as a catalyst. In a chemical reaction, a catalyst doesn't change the chemical potentials that drive the reaction, but it can speed it up and change the preferred pathway of the reactants. For the economic system, money doesn't change the availability of resources or their energy yield but it can direct the flow of natural resources to the areas where they are exploited faster and most efficiently. This allocation of the flow usually generates more money and, therefore, we have a typical positive (or "enhancing") feedback. As a result, all the effects described before go faster. Depletion can be can be temporarily masked although, usually, at the expense of more pollution. Then, we may see the abrupt collapse of entire regions as it may be the case of Spain, Italy, Greece and others. This effect can spread to other regions as the depletion of non renewable resources continues and the cost of pollution increases.

We can't go against thermodynamics, but we could at least avoid some of the most unpleasant effects that come from attempting to overcome the limits to the natural resources. This point was examined already in 1972 by the authors of the first "Limits to Growth" study on the basis of their models but, eventually, it is just a question of common sense. To avoid, or at least mitigate collapse, we must stop growth; in this way non renewable resources will last longer and we can use them to develop and use renewable resources. The problem is that curbing growth does not provide profits and that, at present, renewables don't yet provide profits as large as those of the remaining fossil fuels. So, the system doesn't like to go in that direction - it tends, rather, to go towards the highest short term yields, with the financial system easing the way. That is, the system tends to keep using non renewable resources, even at the cost of destroying itself. Forcing the system to change direction could be obtained only by means of some centralized control but that, obviously, is complex, expensive, and unpopular.  No wonder that our leaders don't seem to be enthusiastic about this strategy.

Let's see, instead, another possible option for leaders: that of "stimulating growth". What does that mean, exactly? In general, it seems to mean to use the taxation system to transfer financial resources to the industrial system. With more money, industries can afford higher prices for natural resources. As a consequence, the extractive industry can maintain its profits, actually increase them, and keep extracting even from expensive resources. But money, as we said, is not a physical entity; in this case it only catalyzes the transfer human and material resources to the extractive system at the expense of subsystems as social security, health care, instruction, etc. That's not painless, of course, but it may give to the public the impression that the problems are being solved. It may improve economic indicators and it may keep resource flows large enough to prevent the complete collapse of peripheral regions, at least for a while. But the real attraction of stimulating growth is that it is the easy way: it pushes the system in the direction where it wants to go. The system is geared to exploit natural resources at the fastest possible rate, this strategy gives it fresh resources to do exactly that. Our leaders may not understand exactly what they are doing, but surely they are not stupid - they are not going against the grain. 

The problem is that the growth stimulating strategy only buys time (and buys it at a high price). Nothing that governments or financial traders do can change the thermodynamics of the world system - all what they can do is to shuffle resources from here to there and that doesn't change the hard reality of depletion and pollution. So, pushing economic growth is only a short term solution that worsens the problem in the long run. It can postpone collapse but at the price of making it more abrupt in the form known as the Seneca Cliff. Unfortunately, it seems that we are headed exactly that way.




This post was inspired by an excellent post on the financial situation written by Antonio Turiel with the title "Before the Wave" (in Spanish).



22 comments:

  1. Completely agree. That process of sacrificing everything to maintain the industrial machinery working recalls me Marx brothers in the famous train scene. At the end, this can only finish with a social upheaval and repression. Sadly.

    ReplyDelete
  2. Thanks, Antonio. I was thinking to translate your post on the economy for "Cassandra". Is it OK?

    ReplyDelete
  3. I guess i have to translate both posts, isn't it?
    ;-)
    Great job, i'll be very pleased to do it.

    ReplyDelete
  4. All that means that I'll translate Antonio's post in English, while Massimiliano will translate it in ITalian

    ReplyDelete
  5. "So, why are our leaders so fixated on growth? Can't they understand that it is a colossal mistake? Are they stupid or what?"

    They're not 'what', they are stupid. Maybe they're also ignorant, too. Nothing in your post says that these people deserve to lead -- and that goes double for the 1%, those who supposedly deserve their fortunes.

    ReplyDelete
  6. Good post. Some additional thoughts:
    There is a paradox that those who are the most positive to the capitalist society and modern technology don't seem to believe in it. Wasn't it the whole idea that we could work a bit less and that industry, technology and energy should relieve us from the toil of work, give us more leisure, more time to enjoy culture or whatever we want to do? How come that those who want that are against a society without growth, a society where people work less and not more?

    Another, equally important function of growth is to mask exploitation. In a stationary economy, forms of profit would lead either to inflation or to that money is transferred from the poor to the rich. And, well, money is transferred from the poor to the rich constantly, and it is only by growth that the poor don't end up starving (which they still do in many parts of the world) or making revolution. Which then is another reason for why growth is so necessary for the stability of our society.

    ReplyDelete
  7. Gunnar is spot-on: growth provides today what the Debt Jubilees of ancient times used to do: protection for the debtor.

    Can anyone see a way out of this, short of going Sharia and abolishing the idea of lending at interest?

    ReplyDelete
  8. Gunnar, you are spot-on, indeed. I didn't discuss the question of social inequality in this post, to keep it short. But, as I hint in the text, money as a positive feedback continuously transfer wealth from the poor to the rich. This is masked by growth, but when growth stops, the king is naked, as they say.

    ReplyDelete
  9. @Lunchista. It is the tragedy of our times that we never had so much computational and theoretical power as we do. And, yet, all this power, all the ability of building models, all the predictive capability, all the understanding we have of how the system works; well, when handled to a politician it is reduced to the sign of a single parameter called "growth". Positive sign=good; negative sign=bad. That's all.

    It is a nightmare. One of those horrible dreams where you are chased by a monster and you can't move

    ReplyDelete
  10. Ugo: Granted, if you allow me to re-publish this post in Spanish in my blog! ;)

    ReplyDelete
  11. I am glad to have read this paper and the comments.I go with Gunnar as well.

    I have looked also at the paper by Arto Annila and Stanley Salthe that you point to.
    I am interested in their use of the concept of ‘free energy’ - or exergy, because of its importance in the study of ecosystems.
    This passage from A&S’ Discussion makes an interesting statement:
    Utility, that elusive concept, is herein identified with the rate of entropy production; the ultimate but invisible incentive is to disperse energy. Economies evolve by diminishing free energy, equivalent ultimately to increasing entropy, toward more probable distributions of matter under an influx of energy. This reasoning, based on statistical physics, does not undervalue decision making in directing economic activities but allows us to rationalize or framework human behavior.
    In contrast, perhaps, 'life' can seem to work the other way? I came across this curious statement in a text on Global Ecology about 'living material' as geological substance: it [living material] has a huge free energy - exergy (similar to fresh lava, but more durable) .
    As physicists, what do you make of this?

    With an agricultural science background I am interested in soils, with their enormous numbers and quantity of microbes. Mobile microbes require water films and react to water stress – particularly from matrix tension and the osmotic effects of dissolved ions – and water stress is said to be associated with a reduction in the ‘free energy’ of the soil.

    It seems possible, however, to have a very rich living environment exhibiting a rapid and large flux of energy and nutrients (with enough water) that will increase over time the total free energy of both the living material, and the total free energy of the system as a whole.

    On the other hand, our dissipative recent economies seem to be based on a constant belief in ‘shortage’, despite our introduction of huge stocks of fossil energy. While the advantages of division of labour and economies of scale have enabled astonishing innovation and expanding knowledge bases, as Gunnar has noted there is a distinct lack of ‘richness’ in the texture of society. Systems are highly stressed.

    My vision of a fertile and increasingly fertile, soil, perhaps could be something more than a metaphor?

    ReplyDelete
  12. Like penguins on an ice flow No one wants to be first but, once it starts, don't get crushed in the stampede.

    ReplyDelete
  13. OK, Antonio, we go Spanish, English and Italian, all together!

    ReplyDelete
  14. Phil, I think that Annila's paper is a true mine of ideas. Very tough stuff, however. I am working on it and I am also in contact with Annila. We are comparing the respective thermodynamic visions of the economic system. Mine is based on system dynamics, his is based on statistical thermodynamics. I must confess that he is several steps more advanced than me; I think. But i do think that if a synthesis were possible, we would advance a lot in understanding these things. But damn tough, as I said....

    ReplyDelete
  15. What I find characteric about growth is this image of "the economy is growing", "the economy is growing" as if with no growth everything would be at a standstill, when a no growth economy is "the same numbers of cars as previous year produced", "the same number of barril consumed", "the same number of wheat tons consumed", "the same number of Kwh consumed" etc
    So not a stable thing in anyway and the picture is much worse ..
    Then of course the fact that growth is necessary to have credit working properly (especially in current financial system) and the current mountains of debts are just the side effects or projection of the belief in eternal growth, belief which even if it remains, is countered by current natural ressources constraints, and these mountains of debt do not know where to seat anymore..
    And from an economic theory point of view, a point on which Friedmann and Marx are in full agreement, is that within the theory basically natural ressource are valued at zero, only the cost to extract them enters the theory (and the word commodities has in itself a kind of "supposed to be infinite" or renewable resounding I find, raw material being clearer..).
    Also from a GDP point of view, capex spending and opex spending aren't differenciated at all, so that if you spend 100€ in a gas bill or 100€ to insulate your house or building, it is considered as exactly the same thing.
    And a lot of lies going on as well, for instance was reading a Naomi Klein post recently, where she is countering some declarations in the WSJ that if Chili didn't suffer so much damages as some other countries from earthquakes it was due to friedmann policies, when in fact the building codes date from Allende time, and Friedmann was thinking of removing them ... :
    http://www.guardian.co.uk/commentisfree/cifamerica/2010/mar/03/chile-earthquake

    Overall as we can for sure not define an "absolute price" for natural resources and especially non renewables ones (guess that one should be infinite then), the only way to approach this is most probably through volume based taxes on natural ressources, which in itself would push everything to less "natural ressources opex kind used by the economy or products". The other key aspect being of course inequalities and unemployment (that one being not so clear if natural resources valued much higher than today compared to work).

    I also find it quite telling that the US oil peak in 1970 coincide with the full abandonment of Bretton Woods (gold standard) in 1971, and then the dollar starting to be called petro dollars and keeping its reserve currency status (this being also linked to the US military ensuring the bulk of the "energy security" job, and somehow US defense budget could be considered as a US "gas tax").
    Maybe we could also look back at what the "pysiocrats" were saying ? (kind of Malthusian or limits to growth before the term ) :
    http://en.wikipedia.org/wiki/Physiocrat
    http://en.wikipedia.org/wiki/Fran%C3%A7ois_Quesnay

    Anyway great post Ugo, and you're doing a great European or even languages networking job ! :)

    Overall to have these "financial guys" take the lead in political power is kind of scary to say the least, the "fundamentals" being scary enough ..

    ReplyDelete
  16. Yves, you too noted the coincidence of Bretton-Woods and peak oil in the US, right? Very few people did, and even less speculated on the reasons for the correlation. There are reasons, indeed!

    ReplyDelete
  17. Also seems to me that with respect to the financial world (i'm not an expert at all) a key aspect more than taxes on transactions and the like, could be to highly decrease its complexity in terms of "kindof products", and all the "over the counter" transactions that are taking place, that is limits the financial products basically to "shares, bonds, futures, credit between banks", remove all this derivatives of derivatives crazyness and hyper leveraged stuff, and have all transactions auditable and labeled around these products. That is bringing back financial role to be "investment judgement" more than "nobody understands what's going on anymore and more or less betting everywhere".

    ReplyDelete
  18. Global civilization posits a short-term narrative. Our remote pre-agricultural ancestors (and many indigenous peoples today) place value on considering the impact on the "seventh generation" of our descendants.

    ReplyDelete
  19. Perhaps the interesting thing is not to discuss growth or zero-growth but to free our minds from at all use economic growth as a good indicator of development of any kind, whether it is good or bad. Growth is, in this perspective not the problem and certainly not the solution, but just a symptom of other things.
    I expand that thought in the post:
    Growth as a symptom and not a problem?, http://gardenearth.blogspot.com/2010/09/growth-as-symptom-and-not-problem.html

    ReplyDelete
  20. Ugo,

    Firstly my thanks to you for an article on this topic that is sensible and useful which had no major technical mistakes. Such articles, believe it or not, are rare.

    Regarding:

    "Phil, I think that Annila's paper is a true mine of ideas. Very tough stuff, however. I am working on it and I am also in contact with Annila. We are comparing the respective thermodynamic visions of the economic system. Mine is based on system dynamics, his is based on statistical thermodynamics. I must confess that he is several steps more advanced than me; I think. But i do think that if a synthesis were possible, we would advance a lot in understanding these things. But damn tough, as I said...."

    Arto's conception of an economy is "physics first". In my opinion, and he'll not agree, there are "realms" of least action. One such realm in human valuation, so there are many occasions where least action will occur in the domain of human thought but which is not least action thermophysically.

    This is analoguous to string theory where one conceptualises a dimension for each physical force. What I'm saying here is that there is an *effective* dimension for physical action and another for information. What one therefore sees is a two way conversion between thermodynamic entropy and information entropy, so free energy gets converted into structure which then goes on to shape later dissipations of free energy.

    I won't go on, as this is a comment and my approach hasn't been mathematically validated. I will however make some suggestions:

    *Easily* *transportable* sources of thermodynamic growth (oil) is indeed running into a wall right now. However, that doesn't bound average thermodynamic growth (electricity), nor does it bound information entropy growth (education). I agree that trying to continue fossil fuel driven growth is stupid and self-defeating, but the remaining types of growth - particularly in education and therefore efficiency of thermodynamic utilisation - have no currently known bounds. Right now, as far as we know, we can growth those exponentially forever.

    Needless to say I have been studying this for years. I have a book which just reached the market (http://www.freeinggrowth.org/books/) and another cowritten with an Economist due around the summer 2012. And by the way I am open to jointly writing articles on this topic if that should interest you.

    Otherwise best of luck and keep at it! There is too much crankery around this topic out there, and too much iteration of the problems and not anything like enough sane research of solutions. We need more articles like yours to scare up some proper research funding!

    Niall

    ReplyDelete
  21. Niall. thanks for this comment. I must say that I admire those who still have the will and the patience to write about what's to be done to avoid disaster. Personally, I am more and more overwhelmed by the sensation of watching a slow motion train wreck - and being one of the passengers. But it is true that we still need to try.

    About physics, yes, you are pointing at the heart of the matter. Personally, I find Annila's interpretation the most consistent with what I know, but the future is - as always - unpredictable. Maybe there are ways to keep growing in areas which are not so energy expensive. But, I must also add, here in Italy (and for what I know, everywhere) one of the most hard hit area is education. I have 20 years of teaching experience, and the decline in the general ability of students of learning and understanding.... well, who knows?

    ReplyDelete
  22. Like it. Reminds me of Small is Beautiful by E. F. Schumacher.

    ReplyDelete