Increasing global energy prices, exacerbated by Russia’s invasion of Ukraine, and ever-rising concerns about climate change seem destined to focus more attention on the relationship between energy and economic growth.
That’s partly because decarbonisation means a major energy transition away from fossil fuel-powered societies. Currently, however, hydrocarbons still provide 84 percent of global primary energy, a proportion that’s decreased by only four percent since 1990, despite the increased momentum behind efforts to lower carbon emissions.
Although the course of the transition is by no means clear, this continued dependence on fossil fuels is an indicator of their importance to economic systems, which suggests there could be a considerable impact on growth if there are increasingly aggressive concerted efforts to rapidly reduce their supply and use.
Additionally, while many aspects of the transition are uncertain, increasing electrification, such as in the transport sector, is destined to be prominent. Two of the leading technologies replacing fossil fuel-powered thermal plants for electricity generation are solar panels and wind turbines. Yet, some experts consider those less efficient ways to produce electricity, which again raises the question of what impact on growth the shift may have.1Energy efficiency can be defined as the ratio of usable energy output to the energy input. The Energy Returned of Energy Invested (EROEI) is used to assess the efficiency of energy production by dividing energy returned by energy invested. There’s considerable academic debate about EROEIs. For example, Weissbach et al say that nuclear energy has an EROEI of 76:1, while Hall et al give a nuclear EROEI range from 5:1 to 15:1. There is also a large range in the estimates for hydrocarbons. For wind, the ratios are 4:1 (when storage is factored in) and 18:1, respectively. A 2016 paper found solar can reach 30:1 and that “distributed mini-grids with penetrations of solar PV up to 50% of annual generation can exceed the EROI of some fossil-based traditional centralized grid systems.” The Levelised Cost of Electricity—the cost to build and operate a power plant divided by its total electricity output—is also used to compare the costs of electricity sources, but it has limitations. Exergy economics expert Tiago Domingos from the University of Lisbon argues that an improving EROEI doesn’t necessarily imply higher growth, as a key process for determining growth is not just the conversion of primary energy (e.g. coal) into final energy, such as electricity, but the transformation of the final energy into useful energy, such as powering a tractor or lighting a bulb.
Orthodox Model
Mainstream neoclassical economics explains growth as driven by technological change and improved labour productivity, which needs capital, entrepreneurship, labour, and land—known as the ‘factors of production’—for implementation.2Nowadays, land is frequently classified as a form of capital, and has been for decades. They use production functions to show how inputs produce economic output. Growth is measured as a periodic change in Gross Domestic Product (GDP).3GDP is a measure of the value of the output of an economy and is calculated in three different ways that are supposed to produce the same figure. The first is based on all spending (consumption, government spending, investment, and net exports), and the second is the value of all goods produced. The third is the total income for worker (salaries) and owners of capital (dividends, rent, and interest).
For decades, this approach has been challenged by some physicists and a variant of ecological economics known as exergy economics.4Exergy is defined as: “The maximum useful work which can be extracted from a system as it reversibly comes into equilibrium with its environment. In other words, it is the capacity of energy to do physical work.” Sometimes also known as biophysical economics. One of the core criticisms is that energy is not properly accounted for in influential models such as the Solow-Swan Growth Model, using an aggregate production function such as the Cobb-Douglas Production Function.
For example, in the latter there is a component known as the Solow Residual that refers to growth not accounted for by labour and capital. In general, neoclassical economics has assumed that productivity increases (i.e., efficiency improvements), often due to the application of technology, fill the gap.
Around two decades ago, Robert Ayres, a scientist who has argued for over half a century that growth models need adjusting, worked with INSEAD colleague Benjamin Warr, to produce an improved aggregate production function. They found that if “useful work” (exergy) was introduced alongside labour and capital, “the historical growth path of the US is reproduced with high accuracy from 1900 until the mid 1970s, without any residual except during brief periods of economic dislocation, and with fairly high accuracy since then.”5Useful work is defined as the sum total of all types of physical work by animals, prime movers and heat transfer systems; nowadays, in the field of exergy economics, it is more commonly referred to as “useful exergy”. In 2011, the authors described useful work as “calculated from primary energy inputs multiplied by an empirically estimated average energy conversion efficiency, which is a function of changing technology over time”. This paper provides an overview of the development of economic growth theory and the competing explanations. They expanded their revised growth model to account for information technology.
On Heat
The challenge to neoclassical economics from Ayres and others starts with the laws of thermodynamics. The first law states that energy can’t be lost or gained but can only be converted. The second states that when energy is transferred or transformed, it converts from a more orderly form to a less orderly one, which is known as increasing entropy. That also means reduced exergy, the part of energy that’s available to do work.6The component that doesn’t perform any work is called ‘anergy’.
Exergy economists say biophysics should inform economic growth models, as the amount of exergy and the efficiency of harnessing it are integral to what activity can occur. This group of economists want economic growth positioned within the constraints of the physical world rather than limited by the self-contained models of economics.
Another pioneer in the field, Nicholas Georgescu-Roegen, railed in a 1976 book about the failure of economics to incorporate an understanding of thermodynamics into mechanistic models that focused on “utility” maximisation by self-interested individuals. “The crucial point is that the economic process is not an isolated, self-sustaining process,” he wrote.7Partly due to constraints on energy resources, Georgescu-Roegen thought that it was fallacious to think that improving technology could feed a growing world population, and that, along with reducing population growth, a “logical panorama for the future of mankind is a radical deurbanization with most people practicing organic agriculture on family farms and relying on wood for fuel and many materials, as in the traditional villages”.
Instead of the type of approach that focuses on the unavoidable depletion of resources including energy, standard economic theory treats energy as just another intermediate good that is assembled into a final product or service. It also assumes that even if there’s less energy, there can still be the same amount of output, as long as a form of capital, such as machines or labour, are substituted for the reduced energy. It posits that as energy costs make up a minor proportion of GDP, energy isn’t a major component of growth.
Industrial Theory
But Ayres, Georgescu-Roegen, ecologist Charles Hall, and company say this is fundamentally misguided. That’s because without energy there can be no activity of any kind; energy is therefore necessary for the existence of labour and all forms of capital. This thinking led Ayres and outspoken economist Steve Keen in a 2019 paper to position energy in an updated production function as not just one of the factors of production, but the “essential” one that impacts the availability of labour and capital.8Keen is the author of 2011’s Debunking Economics, a critique of some core tenets of the neoclassical field.
This type of technical work complements the intuitive understanding that enhanced energy production boosts growth (and that high energy prices constrain it), as with the ability to harness fossil fuels known as the Industrial Revolution that led to rising living standards.9Although economists haven’t proved a causal connection, there’s plenty of evidence of a strong positive correlation between growth and energy use. While other scientific, political, and institutional developments played their part in this rapid transformation, the newfound ability to convert hydrocarbons’ stored exergy into machine power was integral.
“In pre-industrial eras, the degree to which incoming solar energy could be harnessed to feed the working population placed a constraint upon human development,” states an Exergy Economics research group. “The subsequent technological innovations which enabled the “unlocking” of high levels of exergy (the steam engine with coal, the automobile with oil, etc.) then facilitated the explosion of population and welfare seen in recent centuries.”
Modern Privilege
A layman’s way of viewing this is through the time and energy saved by technology. A hunter-gatherer, subsistence farmer, or individual living without piped water spends a large proportion of time and energy on activities that are essential to stay alive. But many people today only have to turn a tap to get water and tap a phone to get food, freeing their energy and time to be spent on other activities.
These privileges come from massive increases in the amount of exergy available per person. According to energy historian Vaclav Smil, in 1800 we had 0.05 gigajoules per capita, which rose to 2.7 in 1900, 28 in 2000 and, largely due to Chinese growth, to 34 in 2020.10A joule is equal to the work done by a force of one newton—the amount necessary to provide a mass of one kilogram with an acceleration of one metre per second squared—acting through one metre. In electrical terms, the joule equals one watt-second—i.e., the energy released in one second by a current of one ampere through a resistance of one ohm. That means that each person has the equivalent of 60 adults working non-stop for them, or more than 200 for modern residents of rich nations.
“An abundance of useful energy underlies and explains all the gains—from better eating to mass-scale travel; from mechanization of production and transport to instant personal communication—that have become norms rather than exceptions in all affluent countries,” Smil wrote.
While there seems to be little debate about the importance of these trends, there’s plenty about their sustainability.
Ecological economists’ critique of mainstream theory has often been focused on finite natural resources as a constraint on growth—today the Degrowth Movement adopts a similar stance to the likes of Georgescu-Roegen. But with their Materials–Energy–Information Processing System, Ayres and Warr constructed a growth cycle—so, mirroring standard economics—that could be perpetuated as long as energy is used with increasing efficiency:11Other academics such as Kummel have produced a “capital–labor–energy–creativity (KLEC) model of wealth production”.
Confused Energy
Still, regardless of the continued availability of resources and the prospects for more efficient energy production, if exergy economists are broadly correct, there’s a serious flaw in the conventional understanding of economic growth, a key measurement of a society’s well-being.12There are many critics of GDP because, for example, it doesn’t account for the value of domestic work, it doesn’t consider externalities such as pollution, or it doesn’t make any distinction between perceived harmful economic activities and beneficial ones. Yet the idea is that GDP is still the best proxy for a society’s well-being, even if it doesn’t include all the metrics that could reasonably be suggested to comprise a comprehensive assessment of well-being.
Critically, a failure to comprehend energy’s role in growth would lead to suboptimal economic projections and energy policies, which is concerning given the climate change-induced energy transition that’s underway.13Keen, for example, has argued that the most influential projections of climate change’s economic impact by William Nordhaus are incorrect and worthless.
In a 2016 book, Ayres argued that the “dangerous” confusion over energy and growth is partly because we live in complex societies that are dependent on science and technology that relatively few understand, including many decision-makers. “Energy and entropy are among the fundamental ideas that cannot safely be ignored,” he warned.14This thinking can also be seen in the writings of Smil, Bill Gates’ favourite author, who suggests that industrial societies cannot be quickly weaned off fossil fuels without causing major disruption. “We are fundamentally a fossil fuelled civilisation,” Smil said in a 2013 lecture.
Hard Times
Some academics, such as David Stern from Australian National University, have concluded that when energy becomes relatively abundant—as was the case for much of the 20th century in rich nations—then its importance to growth reduces in relation to factors such as institutions, technology, and workers’ skills. “However, in the long run, energy supply or energy productivity must continue to increase or eventually energy will again begin to constrain economic growth,” he says.15The University of Lisbon’s Domingos says that the gradual decline in growth is partly due to the failure to maintain an increase in energy supply or efficiency, especially as industrialised countries’ economies became increasingly services-dominated, and so constrained by the productivity of human workers. He says that rather than continuing to rely on debt to fuel growth, it’s possible that artificial intelligence will boost service sector productivity in the manner that increasing energy efficiency has done in the past for industry.
This suggests that in Europe and the US in recent decades there’s been little reason for policy-makers or the public to pay too much attention to the role of energy, and it’s only during periods such as the 1970s oil shock, and accompanying ‘stagflation’, that it gained prominence. Clearly, now is another such period, given the energy crisis, which has already once again caused high inflation and reduced growth, and the clean energy transition, which is designed to rapidly minimise carbon emissions, not maximise growth.16Today’s economic conditions show some similarities with the 1970s ‘stagflation’ when rising prices occurred alongside reduced growth.
Given policies designed to reduce hydrocarbon production and use, and shocks such as the Russia-Ukraine war, there are reasons to think growth will continue to be challenged by higher energy prices in the years ahead. But, the size of that challenge may well end up surprising neoclassical economists wielding conventional growth models.
Further reading:
Books
- Energy, Complexity and Wealth Maximization, Robert Ayres, 2016.
- Energy and the Wealth of Nations: Understanding the Biophysical Economy, Charles A.S. Hall and Kent A. Klitgaard, 2011.
- Energy and Economic Myths: Institutional and Analytical Economic Essays, Nicholas Georgescu-Roegen, 1976.
- The Second Law of Economics, Energy, Entropy, and the Origins of Wealth, Reiner Kümmel, 2011.
Papers
- Energy intensities, EROIs, and energy payback times of electricity generating power plants, D. Weißbach, G. Ruprecht, A. Huke, K. Czerski, S. Gottlieb , A. Hussein, 2013.
- EROI of different fuels and the implications for society, Charles A.S.Hall, Jessica G.Lambert, Stephen B.Balogh, 2014.
- Useful work and information as drivers of economic growth, Benjamin Warr, Robert U. Ayres, 2012.
- The role of energy in economic growth, David I. Stern, 2015.
- A Note on the Role of Energy in Production, Steve Keen, Robert U.Ayres, Russell Standish, 2019.
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