Growing Importance of BioPhysical Economics

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* Article: The Need for, and the Growing Importance of, BioPhysical Economics. By Charles Hall, and Kent Klitgaard. Current Analysis on Economics & Finance| 1:2019 | 75-87



"Actual economies are based upon a variety of processes whereby humans interact with nature: Extraction; production; distribution; consumption; and waste production. Material goods and energy-requiring services originate not in markets but in the Earth. But for the past 150 years, economics has been treated primarily as a social science. The conceptual model upon which mainstream (neoclassical) economics bases its analyses consist of a circular flow of income between producers and consumers, mediated by means of markets. In this "perpetual motion" of interactions between firms that produce and households that consume, little or no accounting is given to the flow of energy and materials from the environment and back again, and little account given to human interactions that take place outside of market processes. Analyses by natural scientists (and others) find that the conventional model is simply not credible. In this paper we bring to the attention of the readership of this new journal the approach of BioPhysical Economics, an important but not widely understood development in economic theory. We review these criticisms and offer the basic concepts to construct a completely new approach to economics, one that will probably be essential in our future that is likely to be highly constrained by climatic, other environmental, resource depletion and other BioPhysical issues."


The Argument

"Since the 1980s productivity has grown six times faster than wages, and the rewards have been captured by those at the top of the income distribution.

These new criticisms upon which we focus are aimed at the logical basis of the discipline, its residency within social sciences, and the misrepresentation of the real biophysical underpinnings of actual economies.

They continue and build upon earlier criticisms leveled by economists themselves, including especially Nicholas Georgescu-Roegen (1975), Kenneth Boulding (1961) and Nobel Laureate in economics Wassily Leontief (1982).

Those trained in the natural sciences look at the assumptions and procedures of conventional economics with something bordering on disbelief.

The criticisms of economics as a discipline by natural scientists tend to focus on the fact that conventional (i.e. neoclassical) economics does not qualify as real science because (among many other things) its basic tenets and models:

1) break the laws of thermodynamics and conservation of materials,

2) uses inappropriate boundaries for its analysis and

3) presents its basic tenets as logical givens, or maintained hypotheses, not testable/tested hypotheses.

We call for an integration of economics with natural science. Why should economics be (only) a social science when it is basically about stuff and physical services?

Why should economists be allowed to disregard the fundamental laws of nature and procedures of natural science when all other scientists know that if they did that they would be drummed out of their disciplinary club? This sleight of hand was accomplished in the years following the 1870s, when the focus of political economy changed from the idea that value was produced by the transformation of the materials of nature into exchangeable commodities using human labor, to that of value as the production of psychological, and unmeasurable, human utilities.

One considers economic production a work process, requiring energy, which indeed it is.

The increase in economic production (i.e. GDP) is highly correlated with the increase in our use of fossil fuels and other energy resources.

The availability of fossil fuels and the technologies to use them has meant an enormous increase in labor productivity.

Neoclassical economics gives low value to energy because of its low price, normally only 5-10 percent of GDP. But energy is critically important to economies because of its low price, and because we can do so much work on so little money. ... Hence energy availability is a critical issue in economics.

Real economies include:

(1) energy sources (principally, the sun) that are essential for any economy;

(2) the material that circulates upon the earth’s surface through natural and semi-natural ecosystems; and

(3) the human-dominated steps of exploitation, processing, manufacturing and consumption. Black and white arrows show the transfer of materials and energy through the economy.

There are two critical aspects of energy availability: first, the ability of humans to wrest energy from the Earth and second, the energy (and hence financial) cost of obtaining that energy. ... The mainstream view holds that if money is available, energy will be forthcoming. ...

The countervailing view, held by, for example, many geologists, is that the Earth has finite energy supplies, and that as time passes energy resources, like all other mined materials, will be depleted.

For Hubbert the issue was not ―when will we run out of oil‖ but rather ―when can we no longer count on the production of oil to continue to increase year after year.

According to geologist Colin Campbell we have entered the ―Second half of the age of oil‖, where oil production no longer increases and will soon start declining.

Hubbert famously predicted in 1955 that oil production in the United States would peak in 1970, which it did. U.S. Oil production dropped steadily year after year from 1970 until 2007, when the new technologies of horizontal drilling and hydraulic fracturing generated a renaissance of oil production up to a new peak in 2019. ... Oil companies will soon exhaust the sweet spots available.

The production of conventional oil globaly seems to have reached an undulating plateau since 2005.

The second concern about energy availability centers around the concept of the quality of energy.

All these factors affect the energy required to get that oil to the surface, usually expressed as the Energy Return on Investment or EROI.

The idea of the energy cost of energy and its importance to human culture had previously been expressed earlier by Anthropologist Leslie White (1943), Sociologist Fred Cottrell (1955), and Ecologist Howard Odum (1971).

The EROI of our most important fuels is declining and most renewable and non-conventional energy alternatives tend to have substantially lower EROI.

At the societal level, declining EROI means that an increasing proportion of energy output and all economic activity must be diverted to attaining the energy needed to run an economy, leaving less discretionary funds available for ―non-essential‖ purchases which often drive growth.

There is a lot of oil left in the ground, but not a lot of high-quality oil that can be extracted at large energy profit. Meanwhile oil use continues to climb, although much more slowly than in the past. The growth of OECD economies too is also declining.

We are also concerned that several of the probably most important economic issues in our future are basically biophysical issues.

The Data

"Two recent climate reports, the Fourth National Climate Assessment (a report of thirteen agencies of the U.S. government) and the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) analyze the current state of the climate and future threats of the Business as Usual Scenario.

The IPCC report’s high estimate for warming of the planet is an astounding 6 Celsius, compared to the 1986-2005 baseline.

The report asserted, and backed with evidence, that an increase in greenhouse gases (GHGs), especially carbon dioxide from burning fossil fuels, (but also water vapor), was the source of the disruption of the planetary systems.

Biodiversity loss is another issue that is poorly handled by conventional economics. We are learning about our comprehensive dependence on nature ... as well as more comprehensive but diffuse actions generally known as ecosystem services (Daly 2005). Sometimes a dollar value is attempted for these services, and they tend to be on the same order of magnitude as the total GDP of the planet.

In 2009 a team of scientists headed by Johan Rockström of the Stockholm Resilience Centre published an article in Nature delineating nine ―planetary boundaries‖ of human activity. They conducted painstaking statistical work to compare current levels of environmental impact of human society such as atmospheric carbon dioxide, biodiversity loss, chemical pollution, disruption of biogeochemical cycles, freshwater use, and land-use changes. They concluded that three of these boundaries have already been exceeded.

The new Anthropocene epoch is likely to be significantly different, and more chaotic, than anything our species has ever seen."

The Pre-History

"More generally nearly all early economists, as reviewed below, had at least some understanding that wealth came originally from nature.

It was not until the age of fossil fuels and the industrial revolution that the idea of the self-regulating economy emerged.

The first group of classical political economists, called the Physiocrats, believed that the source of value and wealth was in the land and the agricultural labor that transformed it.

Adam Smith ... held that the origins of wealth could be found in the number of productive laborers and the individual productivity of each worker.

In the 1890s, neoclassical economist Alfred Marshall would argue that when capital was the primary factor, production would exhibit increasing, rather than diminishing, returns. BioPhysical economists attribute this increase in output to the harnessing of fossil fuels (i.e. a biophysical issue) instead of some miraculous property of the abstract, and difficult to measure, concept of capital.

Marx realized, and expressed in the first volume of Capital, that human labor, on its own, could create nothing (Marx, 1976). Human labor could only transform the products of nature.

Marx also realized that humans cannot perform labor without being supplied with (food) energy and rest. Machines can also degrade with either overuse or disuse (i.e. rust). This makes Marx’s theories of value consistent with both the first and second laws of thermodynamics.

Instead of a steady state Marx emphasized periodic crises grounded in the dynamics of capital accumulation.

Within four years of the publication of the first volume of Marx’s Capital there appeared a new approach to the theory of price and value. The labor theory of value, which depended upon an objective counting of the costs of production, most importantly human labor, was replaced by a subjective theory of utility.

This approach, originally called marginalism, became the basis of what we now know as neoclassical economics.

All believed that one could understand the economy simply by concentrating on the process of exchange.

For these theorists, value and price were determined by subject desires of consumers, and value, like beauty, was in the eye of the beholder. ...

Price was determined by marginal utility, or the extra satisfaction achieved by consuming one more unit of goods or services. ... Walras referred to it as rareté.

Marginalist economists had to make several abstract assumptions in order to constrain human behavior to that which could be analyzed by means of differential calculus.

People were declared rational and self-interested with selfregarding preferences. Utility was endemic to each individual and one could not compare interpersonal utility. Humans were also considered insatiable in their desires.

Marginalist economists had to make several abstract assumptions in order to constrain human behavior to that which could be analyzed by means of differential calculus. People were declared rational and self-interested with selfregarding preferences. Utility was endemic to each individual and one could not compare interpersonal utility. Humans were also considered insatiable in their desires. The theory of production and the theory of distribution became one and the same.

Now price was determined in the sphere of exchange by the interaction of supply and demand and price competition among competitive firms.

From a BioPhysical perspective, economics became analytically divorced from its material base. The absolute scarcity of energy and resources was relegated to the peripheries of economic theory, to be replaced by the relative scarcity resulting from the insatiable desires of humans.

If humans are truly insatiable, how can we possibly live within nature’s limits, especially since a system in overshoot cannot grow its way into sustainability.

Here we must add another myth: that equilibrium prices are determined by the interaction of supply and demand in impersonal and competitive markets.

Those familiar with the world of corporate decision making are likely to understand that prices are most often set administratively. Corporations with enough market power determine their prime costs (energy, materials, labor), then figure out what profit rate they must achieve in order to acquire enough access to finance, then set prices accordingly.

Keynes considered himself a moderate conservative who wanted to save capitalism from its own worst nightmare, unsustainable levels of unemployment and poverty.

Keynesian economics lost favor when it could not explain stagflation, which, incidentally, BioPhysical economics had less trouble in doing.

We believe it is time for a new theory grounded in the unity of natural and social sciences. We call this theory BioPhysical Economics."

The Origins and Development of BioPhysical Economics

"In a 1984 paper by Cutler Cleveland, Robert Costanza, Charles Hall, and Robert Kaufmann in the respected journal Science ... the authors argued that the goals of stable prices, full employment, and economic growth were not met after the 1970s because of a decline in resource quantity and quality. In the initial paper the authors presented strong econometric evidence (R2=0.98) that output is linked to fuel use, and that the increase in labor productivity was due to an increase in energy use.

Their analysis was based in part on the concept of a general and continuous decline in Energy Return on Investment (EROI), and they concluded that the lack of alternative high-EROI energy resources will limit future economic growth.

In 2001 Charles Hall and colleagues published a paper in BioScience titled ―The Need to Reintegrate the Natural Sciences with Economics‖ (Hall et al. 2001). They argued that wealth is not created in markets, but in the natural world and the energy-requiring processes that upgrade matter.

They also found that energy was more important than labor and perhaps capital.

Economic analysis should include the important role of energy -- as well as other resources, more explicitly.

Murphy and Charles Hall presented evidence that the longterm economic slowdown and the financial crisis of 2008-2009 could be attributed to changes in energy supply and fuel prices. Myriad papers refining the measurement of Energy Returns on Investment appeared in a special issue of Sustainability, edited by Charles Hall. Kent Klitgaard and Lisi Krall began to explore the internal dynamics of the processes of growth and accumulation in a capitalist economy. They argued that the inner essence of a capitalist economy is based on economic growth, and that a steady-state economy would result in prolonged to permanent depression if society’s institutional structure were not changed.

In 2018 Hall and Klitgaard published the second edition of Energy and the Wealth of Nations. It is our most comprehensive effort at integrating the analyses of biophysical sciences with institutional and heterodox political economy. The authors argued that economics must be consistent with how nature works and with how actual economies work. They proposed that the end of the fossil fuel era will not be an easy one.

Of particular interest among many investigators is the determination of the degree to which renewable technologies, such as photovoltaics and wind turbines, can take over from more carbon-intensive fossil fuels."