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New paper summary: Insights into the Interdependence of Growth, Structure, Size and Resource Consumption of the Economy

Insights into the Interdependence of Growth, Structure, Size and Resource Consumption of the Economy

December 5, 2021

Carey W. King

 

This blog summarizes outcomes from my most recent publication:

King, Carey W. (2022) Interdependence of Growth, Structure, Size and Resource Consumption During an Economic Growth CycleBiophysical Economics and Sustainability, volume 7, Article number: 1. Free online access: website link and pdf.

 

Background

The purpose of this paper is to discuss the dynamic interdependencies among growth, size, and structure of an economy using outputs from an updated version of the Human and Resources with MONEY (HARMONEY) model that was published in 2020. This new version is HARMONEY v1.1.

Because of its structure, the HARMONEY model helps “narrow the differences” between economic and ecological viewpoints, which as the late Martin Weitzmann suggested, provides value by creating enhanced understanding of economic dynamics. That is to say, because the model simultaneously tracks physical and monetary stocks and flows, by including physical resources and constraints along with macroeconomic accounting and debt, HARMONEY speaks the language of both economists and physical and natural scientists.

I summarize the following insights from the paper:

  • Insight #1: Efficiency begets more consumption and accumulation, not less (Jevons Paradox)
  • Insight #2: Economy Shows Same Energy-Size Scaling as Biological Growth
  • Insight #3: Enhanced Interpretation of Decoupling Resource Consumption from GDP
  • Insight #4: Labor (wage share) vs. Capital (capital share) vs. Resource Consumption Tradeoff
  • Insight #5: Evolution of Economic Structure and Complexity

 

See below for “How the Model Works” and of course you can read the full paper for free.

 

Insight #1: Efficiency begets more consumption and accumulation, not less (Jevons Paradox)

One of the frustrating aspects of reading most journal papers and discussions of economic modeling is the treatment of the concept of energy efficiency.  Given the HARMONEY v1.1 assumption that higher profits translate to increased investment, increasing energy efficiency clearly enables increased natural resource depletion (Fig. 1a), while enabling the economy to achieve higher resource extraction rates (Fig. 1b), population (Fig. 1c), capital accumulation (Fig. 1d), and net output (or GDP, not shown). In other words, the HARMONEY model supports the Jevons Paradox, or backfire effect, in that higher fuel efficiency in operating capital increases overall economic size and consumption. This theoretical finding is consistent with studies supporting the evidence for a strong rebound effect, as well as the general observation that over the course of industrialization to date, the human economy has indeed invented and employed more efficient processes while at the same time consumed more energy decade to decade.

 

Figure 1. HARMONEY shows how increased resource efficiency of capital (e.g., as fuel) enables more growth and resource depletion.

 

Insight #2: Economy Shows Same Energy-Size Scaling as Biological Growth

Figure 2 (Figure 4 in the paper) demonstrates an additional explanation of the relationship between natural resources consumption and growth by making an explicit comparison to biological growth. Figure 2a compares a typical metabolism versus mass trend (for a cow starting from birth per West et al. 2001) to corresponding results from the HARMONEY model.  Here I’m explicitly comparing two things.

First, an animal’s metabolism compares to the natural resources consumption in HARMONEY, and to total primary energy consumption in the real world data: animal metabolism compares to economy energy consumption.

Second, animal mass compares to physical capital (like cars and buildings) in the economy: animal mass compares to economic (physical) capital.  In the real economy there is a problem with adding up all the capital, but that is a much-discussed longer story, so I won’t go into that here.  Thus, most existing studies that make the economic-biological growth comparison plot primary energy versus gross domestic product (GDP), which is not as consistent of a comparison.  However, in HARMONEY, capital is a well-defined concept that can be summed consistently so I plot resource consumption versus both capital and GDP.

Figure 2a displays curves for an animal (e.g., a cow) total metabolic power and basal metabolic power, scaling with mass to the 0.5 and 0.75 power, respectively. The difference between “total” and “basal” is the metabolic power allocated to growth of new mass (shown at the bottom of the chart). One important point is that most organisms grow only to a certain size, with the trajectory of Fig. 2a moving up and to the right, eventually stopping at some point (indicated by the big red dot). The HARMONEY scenarios (assuming full cost pricing) show the same type of trajectory.

Figure 2. A comparison of patterns between (a) biological growth (metabolism and mass) and (b and c) economic growth (natural resources consumption and (b) capital and (c) GDP.

 

Figures 2b and 2c show the full cost pricing simulation for HARMONEY to compare to biological growth.  Just like in growth of an animal, the economy grows until a point at which it stops and remains at a steady state value of resource extraction, GDP, and capital.  Also, total and “basal” metabolism (for animals) and resource consumption (for the economy) come together at the end of growth (which is pretty much the definition of the end of growth).

Figure 2c shows the gray line from a simulation which assumes increases in resource efficiency of capital (like fuel efficiency, same as results in Figure 1). Again, you can see that the final values of GDP and resource consumption rates are higher if the economy can operate capital at higher efficiency.  We can also see that the resource extraction scales pretty similarly to both capital and GDP.  It is an open question as to how insightful it is to relate economic metabolism to GDP instead of capital; perhaps both are useful.

 

Insight #3: Enhanced Interpretation of Decoupling Resource Consumption from GDP

This paper has much to say on the issue of relative decoupling defined as increasing GDP faster than increasing resources consumption.   Decoupling can be envisioned by plotting data as in Figure 3 which shows the growth rate (e.g., the rate of increase) of energy and resources consumption versus the growth rate of GDP.  Global data use real gross world product (GWP) and global primary energy consumption.

Figure 3.  (a) Global data showing the growth rate of primary energy consumption versus growth rate of real gross world product.  (b) Comparable data from the HARMONEY model for growth rate of resources consumption versus growth rate of GDP.

 

Relative decoupling occurs when the growth rate data are below the 1:1 sloped line, in the shaded area (Figure 4).

Figure 4. Relative decoupling occurs when the growth rate data are below the 1:1 sloped line, in the shaded area.

 

Figure 5 shows that both the global data and the HARMONEY simulations show the same temporal trend which is to move in a clockwise direction in the figure.  First the both energy and resources consumption increases at nearly the same rate as GDP, and they both increase growth rates (which is to say grow faster over time).  This is to say the growth rates move up and to the right along the 1:1 line.  Second, once growth rates no longer increase, they move down and to the left into the relative decoupling zone.  For the global data since the mid-1970s, GWP has grown at about 3%/year and primary energy consumption at about 2%/year.

Figure 5. Both the (a) global data and (b) HARMONEY simulations show the same clockwise trend over time.

 

One important interpretation of this trend in growth rates goes against how most people think of the role of energy efficiency in relative decoupling.  A common interpretation of relative decoupling is that it occurs because the economy becomes more efficient in its consumption of energy in producing the goods and services of which GDP is composed.  However, when the HARMONEY model results reside in the decoupling zone, there is no change in any parameters of the model that can be associated with resource efficiency!  In fact, the opposite is the case: due to resource depletion, in the relative decoupling phase the dominant feedback is one of decreasing efficiency in that more resource consumption is required to extract a higher rate of resources.

The HARMONEY model moves from the 1:1 “full coupling” line to the relative decoupling zone because the GDP and resources consumption can no longer increase at increasingly high rates.  That is to say, not only does a stage of relative decoupling occur during periods with no perceivable increase in device energy efficiency, the shift to this stage of growth is evidence for limits to growth, not evidence against limits to growth. In HARMONEY v1.1, resource limits eventually constrain growth to go slower, and eventually go to zero, due to the definition of the forest-like natural resource in the model.

However, this is not to say that increasing resource efficiency is completely unassociated with higher levels of relative decoupling.  Figure 6 shows that increasing the resource consumption efficiency of machines, the economy can move more deeply into a state of relative decoupling.

Figure 6.  HARMONEY results highlighting that while relative decoupling is not definitively associated with increasing resource efficiency, an increase in resource operating efficiency of capital does move the results more deeply into relative decoupling.

 

 

Insight #4: Labor (wage share) vs. Capital (capital share) vs. Resource Consumption Tradeoff

Income inequality has been foremost in the minds of many people for the last 10-15 years.  The contemporary explanation is that there is a battle between “labor” (wages) and “capital’ (profits).  One way to measure this “battle” is to compare the share of GDP gong to wages (wage share) versus profits (capital or profit share).

The claim is that since the 1970s workers have lost “bargaining power”, or the legitimacy and support to ask for higher wages, largely because of the decline in support  (including from elected officials) for union membership.   I tested this idea in this paper, and the HARMONEY supports this general premise, but suggests there is more to the story: resource consumption rates.

I model workers having full bargaining power when their wages can increase with inflation.  Figure 7 shows that wage share declines during the growth phase as companies acquire some profit share.  However, once resource extraction rates level off (refer back to Figure 1), wage share rebounds back to its initial higher level and profit share declines to zero.

Figure 7. When resource consumption rates peak (and no longer increase), and when workers can bargain for wages, (a) wage share (the fraction of GDP going to wages) can stay high and rebound while (b) profit share of companies declines to zero.

 

Figure 8 shows that if we slowly remove bargaining power (by no longer allowing wages to increase with inflation) when resource extraction per person peaks (just as the trend begins in the U.S. economy), then wage share either declines (for the “full cost” scenario) as companies continue to invest in capital or wage share remains low (for the “marginal cost scenario).  See the full paper for descriptions of two different assumptions for production costs.

Figure 8. When resource consumption rates peak (and no longer increase), and when workers can bargain for wages, (a) wage share (the fraction of GDP going to wages) can stay high and rebound while (b) profit share of companies declines to zero.

 

These results show that nature of the distribution of economic proceeds changes once the economy stops growing. As one might guess, it is harder to make profits in a time a stagnant energy and resource consumption rates, and in the face of that slowdown or stagnation, profits can be maintained with the sacrifice of wages.  The HARMONEY model suggests this might be what happened to U.S. labor starting in the late 1970s and early 1980s.  Yes Ronald Reagan was elected President and he was a “union buster”, but we might also ask about the forces that propelled Reagan (and other business friendly legislators) to office and supported a reduction in labor-friendly policies.

 

Insight #5: Evolution of Economic Structure and Complexity

In a 2016 paper (pre-print and blog) I tracked the changing dynamic structure of the U.S. economy since 1947 using (information theoretic) metrics that quantify the distribution of the flow of money within the economy (specifically the input-output “Use” tables).  In Figure 9 I show two images that summarize some of the simulated HARMONEY scenarios as compared to the calculations from the U.S. data.

Figure 9a provides two metrics (mutual constraint & conditional entropy) that when added together form a third metric (information entropy) that is plotted in Figure 9b.

Why should we care about these metrics?  Many people view information entropy as a metric of complexity.  Higher information entropy means higher complexity, where complexity in the economic context means the economy is performing a more diverse set of activities with each activity associated with more equal contributions.

 

Figure 9. Information theoretic metrics that quantify the internal structure of the economy over time.  The data with large red circles and dashed lines show calculations from my previous 2016 paper. The lines without circles are simulated trajectories using HARMONEY v1.1.  NOTE: mutual constraint + conditional entropy = information entropy.

 

Figure 10(a-left) shows that both the U.S. data and the HARMONEY simulations show a counter-clockwise pattern during an expansion (fast-growth phase) that eventually leads to a slower-growth phase (after 1997 in U.S. data).

Figure 10(b-right) shows information entropy over time, and both the U.S. data and the HARMONEY model show three successive trends from increasing to constant to then decreasing information entropy.  Importantly (the paper describes more fully) the change in trends in Figures 9 and 10 relate to changes in both (i) the rate of resources (or energy) consumption and (ii) the cost of energy. That is to say there are similar reasons why there are changes in trends in Figures 9 and 10 for both the U.S. economy and the HARMONEY model.

Figure 10. Same as Figure 9 but with added red shaded arrow to emphasize the broad trend.

 

The comparison on Figures 9 and 10 provides evidence that HARMONEY accurately represents internal changes in structure and complexity of a real-world economy during a growth cycle.

 

Conclusion & Takeaways

The key takeaways are that both animals and the economy require energy consumption and resource to (1) operate their existing mass and capital, (2) make new mass and capital, and (3) distribute and acquire energy.  If you put these concepts into an economic model, as done in HARMONEY, you are a big step towards enabling your model to realistically describe energy-economic interactions.  This type of consistent modeling is important, for example, for the modeling of a low-carbon energy transition.  A low-carbon transition will very likely require major shifts in economic structure due to shifts (downward) in energy efficiency (think CO2 capture plants) and increase allocation of resources to make new capital (such several terawatts of wind, solar, and battery capacity across the globe).  I continue to work on HARMONEY to inform the structural dynamics of economic growth in ways that are not possible using the usual (e.g., neoclassical growth) methods.

 

How the Model Works

HARMONEY v1.1 is a system dynamics model centered on simulating a set of ordinary differential equations using stock-flow consistent tracking of monetary flows.  HARMONEY v1.1 is still a toy model, which is to say it is not yet calibrated (we’re working on it!) to a real economy, such as the United States.  Nonetheless, it has critical features and structural assumptions that make it applicable and valuable for comparing its trends to long-term trends in real-world data.

This is to say, an important part of HARMONEY is that it has a conservation of flow principle for both mass (as physical resources, energy or minerals, extracted from the environment) and money (at any given instant flows of money are tracked between firms, households, and private banks).  While this idea has been around for many decades, this is still relatively unique for macroeconomic models.

Here are several assumptions in the design of the model that help explain why it can mimic long-term real-world trends relating energy consumption and economic variables

  • The resource that supports the economy is a regenerative renewable resource stock, such as a forest.
  • Resource (mass, energy) consumption is required for three purposes in the model, just like the real world:
    • To operate machines (as fuel)
    • To become new machines when they are manufactured (embodied in new capital)
    • To “operate” or feed people to keep them alive (as food)
  • Money is effectively defined as all of the following
    • the compensation labor (workers) receive,
    • the profits received by companies,
    • money (as credit) is created when banks give loans to companies to invest in capital at levels beyond their profits, and the money is destroyed when companies pay back debt, and
    • the interest payments on the debt, or loans given to companies.
  • There is no government in the model.
  • Population declines when there is not enough resource consumption for households.

The Energy and Economic Narratives

In my book The Economic Superorganism: Beyond the Competing Narratives on Energy, Growth, and Policy, I describe narratives along two axes (see Figure 1): energy and economics. Because people disagree as to the costs, capabilities, and benefits of different energy technologies and resources, proponents of different visions use narratives to convince stakeholders of the validity of their positions.

Figure 1. A diagram of narratives along two dimensions: energy—fossil versus renewable;
economics—technological optimism of infinitely substitutable technology versus technological
realism that the finite Earth imposes limits to growth.

The two energy narratives (fossil fuels vs. renewable energy) characterize the extreme views regarding the desired sources for our future energy system that best meet our future social and economic needs:

Energy Narrative: Fossil Fuels Are the Future

This narrative recognizes that fossil fuels enabled us to achieve what we have today. A proponent might say: “The physical fundamentals of fossil fuels, such as high energy-density and portability, ensure low cost and their continued dominance. Why not use them? Renewable energy technologies require subsidies to entice investment because they cannot achieve the historical or present levels of low cost and productivity of fossil fuels and related technologies. Therefore, we should promote increased fossil fuel use for the foreseeable future. Fossil fuels, and the technologies we have developed to burn them, enable us to shape and control the environment rather than the reverse situation before we invented fossil-fueled machines. Further, fossil fuels are the best hope to bring poor countries out of poverty while continuing
to increase prosperity within developed countries.”

 

Energy Narrative: Renewable Energy Is the Future

This narrative states we can use renewable energy technologies and resources to sufficiently substitute for the services currently provided by fossil fuels. A proponent might say: “Thank you fossil fuels, but we’ve modernized. We don’t need or want you anymore. Fossil fuel production and consumption create environmental harm both locally over the short-term (e.g., air and water contamination) and globally over the long-term (e.g., climate change) to such
a degree that their continued unmitigated use ensures environmental ruin that will lead to economic ruin. In addition, the concentration of fossil fuel resources means that countries and citizens have unequal ownership of them, creating geopolitical instability over extraction and distribution. Thankfully, renewable energy technologies are now cheap enough to transition from fossil fuels. Further, a renewable energy system is the best hope to bring poor countries out of poverty while continuing to increase prosperity within developed countries.”

 

Both energy narratives use economic narratives to justify their arguments, and these arguments shape energy policies that affect each one of us. Economic theory in turn informs us how to perform calculations that provide insight into the ramifications of choosing one energy pathway versus another.  My book discusses how one’s economic viewpoint, or narrative, can lead one to ignore important similarities and differences between fossil and renewable energy systems.  Here, I only state the economic narratives for consideration.

 

Economic Narrative: Technological Optimism

(There Is Infinite Substitution
of Technology to Achieve Growth and Social Outcomes)

This narrative posits unbounded technological change that creates substitutes for whatever we desire. It does not necessarily deny that the Earth is finite, but it does not believe that this fact affects economic or physical outcomes that impact the overall human condition. It is the view of most mainstream economists. A proponent might say: “Technological innovation has and will always address the pressing needs for society. In order to promote seeking of solutions, we need a signal. That signal is the price of a good, or a ‘bad’ (e.g., air pollution), and the signal is provided by setting up a market. Therefore we must establish and promote free markets, private ownership and profits via capitalism, and business competition. This is the way toward continued growth and prosperity. With regard to energy, as long the aforementioned criteria govern the economy, its price always decreases, so there is no need to worry.  Markets best address socio-economic issues because they process information better than any human regulator or government agency.” Got a problem? Make a market for it.

 

Economic Narrative: Technological Realism

(The Finite Earth and Laws of
Physics Impose Biophysical Constraints on Growth that Affect Social Outcomes)

This narrative takes to heart that the Earth is finite. It is the position of many ecologists, physical scientists, and some economists. A proponent might say: “Humans need food to survive and our economy requires energy consumption and physical resources to function. These facts very much matter for economic reasons because the feedbacks from physical growth on a finite planet will eventually force changes in structural relations within our economy and society more broadly. These changes can have positive or negative outcomes for our perception of the human condition, but to create positive outcomes, we must perceive, accept, and adjust to the physical limits of a finite Earth and relate our economy to physical laws and processes. Markets can work, but they have problems. Theoretically they can include all important pieces of information, but practically, finite time and incomplete information prevents formation of pure price signals.” The narrative is summed up well by a statement attributed to economist Kenneth Boulding: “Anyone who believes that exponential growth can go on forever in a finite world is either a madman or an economist.”

 

Consider these 4 narratives along the 2 axes of Figure 1 anytime you read and article, policy, or book promoting or disparaging a particular energy policy or technology.

How economic theories influence energy policy – Feb. 27, 2021 Opinion Editorial (Austin American Statesman)

February 27, 2021 (OPINION): “How economic theories influence energy policy“, Austin American Statesman

“Simply put, more of us need to think about the broader relationship between energy and economic theory” Read more …

Macro and Climate Economics: It’s Time to Talk about the “Elephant in the Room”

This blog was written for the Cynthia and George Mitchell Foundation, and originally appeared here: http://www.cgmf.org/blog-entry/213/.

This is the first of a two-part series. Part 2 is: “The most important and misleading assumption in the world.

If we want to maximize our ability to achieve future energy, climate, and economic goals, we must start to use improved economic modeling concepts.  There is a very real tradeoff of the rate at which we address climate change and the amount of economic growth we experience during the transition to a low-carbon economy.

If we ignore this tradeoff, as do most of the economic models, then we risk politicians and citizens revolting against the energy transition midway through.

On September 3, 2016, President Obama and Chinese President Xi Jinping each joined the Paris Climate Change Agreement to support U.S. and Chinese efforts to greenhouse gas emissions (GHGs) limits for their respective country. This is an important signal to the world that the presidents of the two largest economies and GHG emitters are cooperating on a truly global environmental matter, and it provides two leaps toward obtaining enough global commitments to set the Paris Agreement in motion.

The economic outcomes from models used to inform policymakers like Presidents Obama and Xi, however, are so fundamentally flawed that they are delusional.

The projections for climate and economy interactions during a transition to low-carbon economy are performed using Integrated Assessment Models (IAMs) that link earth systems models to human activities via economic models. Several of these IAMs inform the Intergovernmental Panel on Climate Change (IPCC), and the IPCC reports in turn inform policy makers.

The earth systems part of the IAMs project changes to climate from increased concentration of greenhouse gases in the atmosphere, land use changes, and other biophysical factors.  The economic part of the IAMs characterizes human responses to the climate and the changes in energy technologies that are needed to limit global GHG emissions.

For example, the latest IPCC report, the Fifth Assessment Report (AR5), projects a range of baseline (e.g., no GHG mitigation) scenarios in which the world economy is between 300 and and 800 percent larger in the year 2100 as compared to 2010.

The AR5 report goes on to indicate the modeled decline in economic growth under various levels of GHG mitigation. That is to say, the economic modeling assumes there are additional investments, beyond business as usual, needed to reduce GHG emissions.  Because these investments are in addition to those made in the baseline scenario, they cost more money and the economy will grow less.

The report indicates that if countries invest enough to reduce GHG emissions over time to stay below a policy target of a 2oC temperature increase by 2100 (e.g., CO2, eq. concentrations < 450 ppm), then the decline in the size of the economy is typically less than 5 percent, or possibly up to 11 percent.  This economic result coincides with a GHG emissions trajectory that essentially reaches zero net GHG emissions worldwide by 2100.

Think about that result: Zero net emissions by 2100 and, instead of the economy being 300 to 800 percent larger without mitigation, it is “only” 280 to 750 percent larger with full mitigation.  Apparently we’ll be much richer in the future no matter if we mitigate GHG emissions or not, and there is no reported possibility of a smaller economy.

This type of result is delusional, and doesn’t pass the smell test.

Humans have not lived with zero net annual GHG emissions since before the start of agriculture.  The results from the models also indicate the economy always grows no matter the level of climate mitigation or economic damages from increased temperatures.

The reason that models appear to output that economic growth always occurs is because they actually input that growth always occurs.  Economic growth is an assumption put into the models.

This assumption in macroeconomic models is the so-called elephant in the room that, unfortunately, almost no one talks about or seeks to improve. 

The models do answer one (not very useful) question: “If the economy grows this much, what types of energy investments can I make?”  Instead, the models should answer a much more relevant question: “If I make these energy investments, what happens to the economy?”

The energy economic models, including those used by United States government agencies, effectively assume the economy always returns to some “trend” of the past several decades—the trend of growth, the trend of employment, the trend of technological innovation.  They extrapolate the past economy into a future low-carbon economy in a way that is guesswork at best, and a belief system at worst.

We have experience in witnessing disasters of extrapolation.

The space shuttle Challenger exploded because the launch was pressured to occur during cold temperatures that were outside of the tested range of the sealing O-rings of the solid rocket boosters.  The conditions for launch were outside of the test statistics for the O-rings.

The firm Long Term Capital Management (LTCM), run by Nobel Prize economists, declared bankruptcy due to economic conditions that were thought to be practically impossible to occur.  The conditions of the economy ventured outside of the test statistics of the LTCM models.

The Great Recession surprised former Federal Reserve chairman Alan Greenspan, known as “the Wizard.”  He later testified to Congress that there was a “flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.”

Greenspan extrapolated nearly thirty years of economic growth and debt accumulation as being indefinitely possible. The conditions of the economy ventured outside of the statistics with which Greenspan was familiar.

The state of our world and economy today continues to reside outside of historical statistical realm. Quite simply, we need macroeconomic approaches that can think beyond historical data and statistics.

How do we fix the flaw in macroeconomic models used for assessment of climate change?  Part two of this two-part series will explain that there is research pointing to methods for improved modeling of what is termed “total factor productivity,” and, in effect, economic growth as a function of the energy system many seek to transform.

The Most Interesting Chart I’ve ever Made: Energy versus Money Leverage

Figure 1 is perhaps the most interesting chart I have ever made. The purpose of this figure (from my publication here) is to provide context into metrics of net energy and see how they relate to economic data. Here, I’m asking a fundamental question: should our (worldwide) society be able to leverage money more than we can leverage energy? My hypothesis is “no” and would be represented by values < 1 in Figure 1. Clearly the plotted ratio of ratios in Figure 1 is not less than one (for all years) per my hypothesis, so why might this be the case?  As I discuss below, understanding the data in Figure 1 is crucial for making better macroeconomic models of the economy that properly account for the role of energy.

NPR_compare_NEPRdirect_World44Only_White

Figure 1.  This is a ratio of how much the worldwide economy leverages money spent by the energy sector relative to how much surplus energy is produced by the energy sector itself.  Specifically this calculation (using world numbers) = (GDP/money spending on energy by the energy system) / [ (world primary energy production – energy spending by the energy system) / energy spending by the energy system)].

I created Figure 1 by dividing the data from Figure 3 by the data from Figure 2.  Figure 2 is a calculation of the leverage of energy, and Figure 3 is a calculation of the leverage of money. I now describe each of Figure 2 and 3.

For a full description of the underlying data and calculations, see Part 2 (and Part 1) of my papers in Energies in 2015.

Net Energy

Net energy provides an additional lens, besides money, to understand how our economy works.  Net energy is the amount of energy that is left over for consumption after we subtract the energy inputs that are required to produce that energy.  The energy production and consumption quantities you see in statistical databases (such as those housed by the Energy Information Administration (EIA), BP, and International Energy Agency (IEA)) is gross energy, often referred to as total primary energy supply (TPES) consumed per year.  For example, the world TPES is approximately 550 EJ as reported by the EIA.

Figure 2 shows the data used in the denominator of the calculation of Figure 1.  The solid red line indicates the average value for the world. The underlying data come from the IEA. This figure indicates that since around 1995, for every unit of energy consumed by the energy industry, the energy industry provides about 14-15 units of energy for all consumers and other industries.  Before 1985, this “energy return on energy invested” was greater than 20 (data are not available to for a viable estimate before 1980).  In the case of this figure, there are no other types of inputs considered besides energy itself.  No wages. No materials. No computers or consultants. Nothing but energy.

NEPRDirect_EachCountry

Figure 2.  This is a ratio of how much net energy the worldwide energy system produces for all other sectors and consumers after it consumes the energy it needs for its own operation.   The solid red line represents the world average.  The dashed red line represents the average for OECD countries only. Each gray line represents the data for one country (the countries with high values are countries that are net energy exporters). Specifically this calculation (using world numbers) = [ (world primary energy production – energy spending by the energy system) / energy spending by the energy system)].

Money Leverage

Figure 3 is about money, not energy.  Consider adding up all energy spending (in money) by the worldwide energy industry and dividing that by the GDP of the world. A typical quantity is 0.04-0.07, or 4-7%.  Essentially this is an input (spending by energy sector) divided by an output (GDP).  In order to compare these monetary data to the net energy data of Figure 2, I need to phrase them in an equivalent manner.  Figure 2 shows energy outputs divided by energy inputs.  Thus, by inverting the monetary energy spending ratio, I turn it from a ratio of input/output to a ratio of output/input.  Thus, if world energy sector spending was equivalent to 5% (or 0.05), 1 divided by this number is 20. Thus, we can say that the economic output of the economy is 20 times larger than the monetary spending of the energy sectors.  Figure 3 plots this ratio for the world.

NPReconomic_World_white_png

Figure 3.  This is a ratio of how much the worldwide economy leverages money spent by the energy sector.  Specifically this calculation (using world numbers) = (world GDP / money spending on energy by the energy system).

Why this is interesting

Fundamentally the ratios of Figures 2 and 3 are about measuring inputs of “something” to the energy industry in comparison to outputs of that “something” consumed or created by the rest of the economy.  In Figure 2 the “something” is energy, and in Figure 3 that “something” is money.  Figure 1 shows the data of Figure 3 divided by the data of Figure 2.

Should the output:input (“leverage” or “return on investment, ROI”) of energy (often termed EROI) be greater than or less than the output:input (“leverage” or “return on investment”) of money?  My hypothesis is that the energy ratio should be larger than the monetary ratio.  Thus, the measure in Figure 1 should less than 1.

The reasoning is as follows.  The energy inputs used in Figure 2 only include energy consumed by the energy industry.  As I wrote before, no other inputs such as wages, materials, offices, or administration are considered.  By considering any number of these other inputs (and converting to units of energy), the energy return on investment ratio can only decrease.  However, the assumption behind the monetary ratio of Figure 3 is that all types of inputs have been included in units of money.  That is to say, the energy sector purchases inputs as energy, machines, and various services from itself and other economic sectors.  Thus, there are many more inputs (theoretically all required monetary investments) considered in the monetary output:input ratio for the energy sector and economy.

So back to my hypothesis that the ratio plotted in Figure 1 should be less than 1.  How can we explain values > 1?  The general (but not satisfying) answer is that GDP (gross domestic product) is a measure of economic throughput that is not backed by anything purely physical, but by what we (as consumers) perceive as valuable.  Thus, we can value a service or product at one level in one year, but change our mind as to the value in another year.  Much value is also currently placed in information-related companies (Facebook, IBM’s Watson, etc.), and there is ongoing debate as to whether the value of this information (e.g., in social network companies) is overvalued.  Is social networking overvalued, as a business, and will these valuations decline if people can’t actually afford to buy new products suggested by the ads targeting them?  I suppose we don’t know the answer, and we’ll eventually find out.

Debt as an Explanation

But I think debt accumulation is likely the best explanation for why the economy seems to be able to leverage money more than energy spending by the energy sector.  To some degree, increases in debt in the 10-20 years leading up to 2008 (when the ratio in Figure 1 reached a value of 1) were responsible for increasing the quantity GDP.   Government and consumer spending beyond their means shows up as increases in GDP.

Also, if we consider increased debt a expectation of increased future consumption, and consumption (and production) require energy, then increases in debt are an expectation for increases in energy consumption.  And don’t get confused here with discussions of “decoupling” energy from economic activity.  There is yet no evidence that worldwide economic growth occurs without increasing total worldwide energy consumption.  Possible evidence for this debt explanation is the fact that debt accumulation stopped in 2007/2007 (with the financial crisis and peak in commodity prices) when the ratio in Figure 1 was no longer greater than 1.  If I were to have the data through 2015, my guess is that the number would have stayed near 1 through 2013/2014 before again increasing in 2014/2015 as oil prices were falling dramatically (assuming the energy return ratio of Figure 2 remained relatively steady).

I also anticipate (could be confirmed by further research) that the ratio of Figure 1 would be < 1 for all years before 1980 leading to the beginning of the Industrial Revolution. Largely speaking, we extract the easiest to reach resources first, and these resources have high net energy (= low cost).  Thus, resources with higher net energy translate to larger values for Figure 2 which is the denominator for Figure 1. Thus, smaller values of Figure 1. Further, I know from my previous research that spending on energy was never lower than around the year 2000 (see my papers here and here for detailed explanations), which is what is indicated in Figure 3 (e.g., the higher the value the cheaper was energy). Energy continually became less expensive since the beginning of the Industrial Revolution until the 1970s and then again (much slower) through the end of the 20th Century.  Thus, the values for Figure 3 (the numerator of the calculation in Figure 1) will always be larger for the previous 100+ years.

This concept of Figure 1 is so interesting because it is likely that the time period of 1985-2007 is unique in all of history as the time period when the economy leveraged monetary spending by the energy system more than the leverage in energy that was provided by the energy system.  This is a ripe area for further understanding of macroeconomic modeling that properly accounts for the role of energy.

How much can the next president influence the U.S. energy system?

There have been dramatic changes in the U.S. energy system under our current president – a big drop in the use of coal, a boom in domestic oil and gas development from fracking, and the rapid spread of renewable energy.

But in terms of influencing energy technology deployment, the next president will have a lot less influence than you might expect.

When it comes to educating U.S. citizens on energy’s relationship to the broader economy, though, the next president could have a great impact. But I’m not holding my breath. In fact, I’d say it’s likely not going to happen.

Here I pose a few relevant questions about energy and the economy that could be asked of our next president and suggest some answers.

Read the rest of the post at The Conversation …