What happened to Economic Growth?

The financial crisis that struck the world back in 2008 seems to have no end. Four and bit years in we’re in the middle of one of the longest economic stagnation in history. Already some are calling it “the Long Recession” or “the Great Recession”. But why is it that economies, particularly those in the West can’t seem to dig themselves out of the mud?

One can concoct various theories. Certainly the mess left over from what amounted to a thinly disguised Ponzi scheme (otherwise known as the Housing Bubble….or perhaps more accurately “the Thatcher/Reagan Bubble”) didn’t help matters. Normally governments would rely on good old fashioned Keynesian policies to get them out of danger here. However the sheer volume of debt for some countries has largely prevented a recovery. While America under Obama (who has attempted to spend his way out of trouble) seems to be handling things better than the UK or parts of Europe, the good times are certainly not rolling again across the pond.

Others would pin the blame on the policy of austerity pursued in several countries. As I’ve discussed at length as regards Europe and the UK, such polices are almost certainly inhibiting growth and slow down economies. So clearly this is having an impact. Indeed a couple of weeks ago, two free market economists who have long argued in favour of Austerity were caught out by a Grad student, who pointed out a load of errors in an economics paper that they had published (should we really be letting people this bad at maths run the world economy?). The ratings agencies seem to agree and yet another one chose to cut the UK’s credit rating recently.

What about peak oil?

However, perhaps the most radical idea is that is that the real reason why the global economy has stagnated is due to the fact that oil prices hit and unheard of high of £147 per barrel in 2008….right about the same time as the crash, likely (so some believe) due to the fact that our planet had essentially hit the limit of oil production capacity (i.e. we just “discovered” one of “the limits to Growth”). I mentioned before how Wikileaks discovered that the Bush Adm. was applying considerable pressure then on OPEC to raise output, but when they failed to do so, many in the Adm. considered the possibility that this was because OPEC didn’t have the production capacity any more (i.e. OPEC production capacity had peaked).

In this article James D. Hamilton, an energy economist, argues the case that one of the key causes of the present recession was the high oil price and we’re not recovering because of constrained supplies of oil.

Others, notably the Post-Carbon Institute from California (a few video’s from them available here) argue that the spike in prices in 2008 represented the world crossing the Rubicon of the end of cheap oil. While there is still plenty of oil, coal and natural gas left, what’s left is much more expensive to produce and cannot be sucked out of the ground at any arbitrary rate of our choosing. They suggests that unless or until some means of growing the planet’s energy supply is initiated, the global economy will simply never recover, indeed we ain’t seen nothing yet!

And before anyone starts wailing about Shale Gas/Tight oil, as I discuss in this post, it’s probable that much of the hype about Shale gas is just that (hype!). In a further more recent post I point out that data (from the EIA and DoE) suggests that the amount of Shale gas/oil that is commercially viable is not nearly as large as previously thought and that output in the US from these resources is never going to be able to meet more than a fraction of the America’s current energy needs.

The Energy – Growth link

That energy and economic growth are linked is not in itself a controversial statement (this paper discusses the topic). I recall a few years ago being at an energy conference where this guy stood up and stated that growth in any economy boiled largely down to two factors:

1) Available energy resources and

2) Technology, notably any technology that allows one to better utilise energy resources

Political issues, whether the regime is led by hardline communists, fascists, free-marketeers or lefty-liberals, matters little. Without a good reliable source of energy an economy will collapse, with it in spades even the most incompetent and clueless government can still see an economic boom.

Energy slavery

And if you think about it they’ve got a point. The industrial revolution was heralded in by the availability of coal. An elite athlete can output about 500 Watts of energy, an ordinary human about 250 Watts while doing hard manual labour, a horse roughly 750 Watts (i.e. literally 1 hp). 1 kg of coal contains about 35 MJ of energy …..or if you consumed that kg over an hour (and used it with say 30% efficiency) enough energy as generated by 6 stout men, 12 labourers or 3 hefty horses. Consider that back at the beginning of the industrial age a bag of coal cost just a few pence it should give you a good idea of why the global economy took off in such spectacular fashion. As it meant a factory owner could literally buy the labour of hundreds of additional “energy slaves” for the price of a few shillings.

Indeed we can trace many boom’s in economic history to booms in energy production. The roaring twenties matches the oil boom in the US, the industrialisation of Communist Russia ran parallel with them opening up the nation’s vast coal and oil reserves. As I mentioned in a prior post Thatcher and Reagan’s “boom” happens to coincide with the end of the 1970’s oil shocks and the North Sea oil industry boom. Clinton happened to be in power at the same time that oil prices dropped spectacularly (graph of that here), likely leading to an increased rate of economic growth.

And the economic downswings? Well the collapse of the Soviet Union (nice article about that here) just happened to start a few years after the country hit a peak in oil production (Russian oil output has since recovered, implying this was an artificial peak caused by soviet mismanagement of oil fields). To make matters worse the soviets had also mismanaged their farming system (overuse and over dependence on fossil fuel based fertilisers, this is also how they ended up draining the Aral Sea). Also at about the same time (in March 1988) a dispute broke out within OPEC . Several countries, notably Iraq and Iran (who were at war), had been cheating on their quotas (selling more oil than they were supposed too). The Saudi’s responded by very publicly cheating on their quota. But they miscalculated and pumped too much oil and the price of oil collapsed. This drove down the revenue the Soviets gained from their diminishing oil output, quickly bankrupting them.

The recession under G. Bush senior happens to coincide with a spike in oil prices due to Iraq’s invasion of Kuwait. The 70’s recessions of course occurred at the same time as the oil shocks of that era. And as noted the 2007 crash happens to correspond to a flat lining of supply and a spike in oil prices.

Critiques?

Of course I would note that I don’t personally quite buy into this “energy is the root of all growth/good/evil in the world” view point. As I noted earlier, what policies a government applies to its management of resources can have a huge impact on their utilisation.

While the economies of the West are in the doldrums, the economy in China and the other so-called “BRICS” are still growing (not as spectacularly as before yes, but still growing). There is also no link between the Wall Street Crash and the great depression of the 20’s and 30’s (the greatest economic downturn in history) and a decline in energy indicators (indeed the opposite is true, energy prices were falling, supplies increasing).

Germany is currently one of the few European economies that is growing, yet energy prices have risen slightly (due to their efforts to increase the use of renewable energy) while overall energy consumption per capita is falling (due to energy efficiency programs). This sort of suggests it’s possible to still grow an economy in the absence of cheap energy while actively reducing energy consumption.

So clearly there is more to economic growth than simply “energy”. Economic policies are important as well as numerous other factors. That said, its certainly not easy to maintain an economy without a reliable supply of energy and I do worry that outside of a few so-called “energy economists” few mainstream economists seem to factor in the importance of energy to economic performance as much as they should.

There may be trouble ahead…..

And that last point is worrying because I’m also unfamiliar with any mainstream economist who seems to have factored in the consequences of our fossil based energy supply entering into a state of terminal decline, so called “peak oil”.

Now I’m not going to split hairs over when peak oil is going to happen (or indeed if it’s already struck), but suffice to say the world’s reserves of fossil fuels are finite, we’ll hit a peak eventually. And even the more optimistic voices suggest the 2030’s and as the Hirsch report points out, that’s still too close for comfort and not nearly enough time to get ready.

If indeed this energy – growth link is true, the result is going to be that post-peak the global economy will stagnate and decline for decades on end with little or no respite. In other words we could see a lengthy period where all the economic indicators are either flat or pointing downwards.

Now if that were to happen one has to ask how then are nations going to pay off their sovereign debts? How indeed are most people going to pay off their mortgages? Who’s going to pay you’re pension? Who will feed China? (actually that’s a silly question President Hu has retired, I should be asking “how will Xi (pronounced “she”) feed China?” :DD).

There are of course solutions, a couple of which I discuss here and here. However, as I also point out many of the “unconventional” fossil fuel based options simply aren’t compatible with a policy of averting dangerous climate change. Indeed a recent report suggests that such a policy could be little more than a fool’s errand. However, the problem with all these options, be it more renewables, nuclear, or again unconventional fossil fuels, is the time it takes to build these systems on the scale we’d need and the enormous capital costs involved in the initial construction phase (we’re literally talking many tens of trillions of dollars here). And in a falling economy who is going to pay for all of that?

Again just to put a number on things, if we assume a modest post peak oil (and only oil) decline rate of just 3%. To offset that and maintain business as usual, would mean bringing online 169 GW’s of power generation capacity (operating with a capacity factor of 90% and boasting a 100% conversion efficiency to end users! ). To replace it with unconventional fossil fuels, 3% per year would necessitate an annual loss of 2.5m bbl/day of production capacity. To put that in context, a recent report by the PCI suggests that the entire Tight oil/Shale oil output across North America will peak in 2017 at an output level of about 2.2m bbl/day (i.e. twenty years of drilling of unconventional oil across America will struggle to cancel out 1 year’s loss of production post-peak oil….what do we do the following year?).

Don’t Panic….we’ll not yet!

There are some in the peak oil movement (so called “doomers”) who seem to delight in going around scaring people about it. In the energy research field it’s the equivalent of sneaking up behind someone and saying “boo”. I’m not trying to do that. There are like I said, solutions. Indeed arguably the best solution is simply energy conservation and better recycling of materials (costs little or nothing to do and saves money!).

But the point is that any solutions to this problem aren’t the sort of thing we can string together the night before. We’re talking here about long term problems that require long term solutions, which will take decades to gradually implement. Solutions which, in order to be successful, require long term commitments both from governments, corporations and international bodies. And indeed most important of all, us the people who are going to pay for all of this, to recognise that we have a problem here and the longer we ignore it, the harder it will be to fix.

For example, many complain that the hysteria over the millennium bug was silly. We spend several years worrying about it and nothing happened. I would counter however that perhaps the reason why nothing happened was because we spend several years worrying about and did everything possible to ensure that the bug won’t bite. The same equally applies to issues such as climate change and peak oil.

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