When, and Why, did the Economy Start to go Downhill
This post is in response to a question to a comment I made
over at:
It is also posted as a series of comments at that site.
rosserjb@jmu.edu asked the question:
“So, greg, please, exactly when out of all that mess was
"the turning point"?” referring to the point at which I said “when the
increasing energy cost of energy and other resource production started to be a
significant problem.” The word “mess” refers
to the entire price history of oil production.
So: The short answer
might be that point when it became (nominally) more profitable to exploit
society, to plunder it, rather than provision it and invest in it. When it became more profitable to be a pirate,
than a builder. (Understanding this
clarifies the motives and actions of the Right, and the modern capitalist.
“Greed is good” is the motto of a pirate, not a builder.) But
this transition itself is a consequence of the increased difficulty in
extracting resources from the environment.
In particular, non-renewable energy resources.
So if you want a date, sometime around the Reagan
presidency, in perverse reaction to the oil crises of the1970’s.
Roughly:
In the beginning, (Well, once the ball got rolling, about
1880.) http://cdn3.chartsbin.com/chartimages/l_oau_dff4ad5a049ca559d9105471f82bf873
the real cost of energy extraction was low, lower than the
cost of developing the infrastructure
needed to distribute and consume the oil.
So the cost of extraction was the benchmark for the price. Only as the
infrastructure for demand was emplaced did demand on occasion drive the
price. In the first half of the 20th
Century, because of the- inconsistent nature of the supply and its irregular
rate of increase, sometimes demand, sometimes supply drove the price.
With the opening of the Middle Eastern fields, supply
smoothed out. Supply and demand both
expanded apace, the price relatively stable and low. Until
the Arab oil embargo of 1973, and the later panic in 1979 due to the Iranian
crisis. The result was an effective and dramatic increase in the *real* cost of
oil to the US, since it now had to hand over an increased quantity of goods and services to pay to import foreign production. Domestic fields were becoming exhausted. New ones (Prudhoe Bay, etc.) more expensive to develop.
In an energy based society such as ours, (almost) all inputs
can be traced back to the energy needed to support them. Thus the size of the economy
can be measured in terms of energy consumption, and this is measured in terms
of energy input. This instead of dollars. With this understanding, the inverse of the
EROI, the energy return on (energy) investment, is the portion of the real economy
which must be devoted to the extraction of energy. Only the remainder of the economy is available
not only to providing services to society, but also to investment and
maintenance.
For EROI, see: "Energy, EROI and quality of life"
Check out: Fig. 1 The
Net Energy Cliff
Now: From about 2004,
supply has been constant, but until the 2008 crisis, demand increased, driving
up the price. Demand and price then
crashed with the recession, increased with the recovery, and recently spiked
again, and is now again depressed.
The question is why is the price, and demand, now
(relatively) depressed.
We return to the short answer, considering the gradually
decreasing EROI, that is, a gradually increasing average real cost of
extraction.
So: We have two
different measures of accounting in an economy:
Energy accounting, and money. Is
the price in money necessarily a faithful measure of the real cost, in energy,
of energy production?
Why should it be?
Instances where monetary price does not reflect cost, real or even
merely monetary, are common occurrences.
Is the current energy market one of them? In particular, we ask: “How can we subsidize energy
production?
Well, we can’t. When
we subsidize something, we divert real resources from elsewhere in the economy
to promote the production of the subsidized good.
We decrease the nominal cost, and therefore the nominal price at which
the good may be offered for profit.
However, the real cost must be greater than if the good were produced
without the subsidy. So when we subsidize the real cost of energy, we are
merely increasing the real cost of production. (Note: Subsidizing production is not to be confused
with subsidizing the capitalization of production.) That
is, because of the cost of our churning resources through the mechanism of subsidy, we are worse off than if we let the price reflect the real cost of
production.
However, we can still manage to increase quantity produced,
and depress price. Especially if we also depress demand. Remember, those resources transferred to
subsidize production can only come from one place: The remainder of the economy, where a portion
of those resources would have gone to maintain and capitalize the
infrastructure which supports the economy, the infrastructure which also
enables the consumption of oil.
How much is the subsidy?
Well, according to: http://thinkprogress.org/climate/2015/11/12/3721677/g20-fossil-fuel-subsidies/
the world formally spends about $400 billion per year, one way or
another subsidizing fossil fuel production.
(The US,
formally, a mere $25 billion.) Given an
inelastic demand curve, this can result in a dramatic reduction in price.
But there are other mechanisms of subsidy. For instance, consider the US trade deficit in goods. All those goods, if made in the USA,
would require energy inputs, and concomitant infrastructure, for their
production. Just as agricultural imports
can be regarded as water imports, the importation of goods can be regarded as
energy imports. So energy supply is increased, while demand is
contracted.
Further, the production cost of fracking, while recently improved,
is still above the current market price of oil. (Externalization of costs also
represents a form of subsidy.) This
production has been financed in large part by massive quantities of debt. This
debt represents an enormous effective subsidy, much, much larger than the
formal subsidies provided the fossil fuel industry, especially those debts,
(and they represent a substantial fraction,) which will never be repaid. Considerations of the relative discount rates
of oil and money, also suggest the actual effective subsidy is much greater. (The discount rate of a non-renewable resource
should probably be considered at most zero, and more likely negative, since all
current consumption necessarily implies less ultimately available in the future,
likely coupled with an increase in demand.) And as above, these debts represent demand
transferred from the larger real economy to support the production of energy.
Infrastructure neglect is also an effective subsidy.
My guesstimate of a price that reflects the real cost,
everything I can think of considered, of oil is somewhere well over $100 per
barrel. The difference between that and
what we actually pay we are passing to the future, our own and that of our
descendants. It is a price we will begin
to pay when the delusion live under (and which requires an input of real resources
to maindain,) can no longer be sustained.
So, sometime around or, actually before1980, the leaders of
society decided to pursue their own narrow and what may ultimately prove to be
ephemeral gains, rather than look after the enduring interests of their society.
The actual process of their choosing the consolidation of power has been noted
elsewhere. (Consider also eg the Exxon
climate data suppression scandal.) They
propounded an ethos to justify their actions, and geared up their media to
convince society of the rightness of those actions. And the people, for their part, got to live
beyond their means, splurging on underpriced energy, their political acquiescence purchased with
their own futures, and that of their descendants. Most of them.
So now society is in a hole, 30 years and many trillions of dollars of
squandered resources and mal-investment, with an economy ill-adapted for a
future of costly energy.
Now some might argue that the economy has not been going down hill for the past 30 or so years. That we have instead made remarkable progress during that time. We will address that issue in the next post.
