Tuesday, August 17, 2004

Applied Economics: Economic Cannibalization and Resource Rush,

Recently Ian Welsh and Stirling Newberry have been writing about very strong duet about what the future economy of the world will look like. It's astonishing and gratifying to read visionary literature like that out there. It's certainly not being produced in the halls of the Academy.

The most recent string of their work is four pieces, two contributed by each that are integrally linked to the future of what is to come. Let us briefly review them before I try to find something perceptive to add to their wonderful work. First Stirling joins the dark side - no umm I mean he comes to agree with me that Supply-side economists of the reformed kind is the only solution to our modern problems. Why? Because it's demand that leads growth, but it's supply that sustains it.

However, Keynes' theory, and those who adopted it, is not merely a theory of demand, but also a theory of supply. Specifically, it is a theory which rests on the idea that capitalism will constantly be creating new supply, and reducing the cost of goods. That it will, then constantly be undercutting its own demand...

Keynesian economics set the two tendencies against each other in a punctuated equilibrium. And here is where the supply-side comes in.

The typical story of a post-war recession runs that the Fed notices that the "economy is overheating", though one could add the codicile of "or the nation is demobilizing from a war". The Fed tightens, or the government cuts expenditures. This leads to a drop in demand. Inventories pile up, and businesses lay off workers, both in manufacturing and in areas sensitive to interest rates. "Inflation" drops, and the fed and the government can put the pedal to the floor and get people back to work. During the post-war Keynesian period, this could lead to astoundingly fast rebounds: payrolls could shoot up by 10% in the space of months, GDP could grow at annualized rates of 10% for a single quarter.

But let's look at this same story from the supply side: the economy is expanding, and technlogy and improvments in business process are making it so that expansion uses less of whatever the resources in short supply are: energy, land, metals, labor. In short, growth rests on the government watching the supply side, and slowing the demand side until the supply side catches up with it. Keynesian Economics is Supply Side Economics. As much as Keynesian economics is known for its viewing the economy through the prism of demand, it spends as much of its effort slowing demand that has out run supply.

Stirling then continues his work, tying it into the long term energy issue.
But, "in the long run we are all dead", the problem for policy today is to address a current problem: namely that demand for energy, particularly oil, is out stripping supply of energy, particularly oil. Give us this day our daily bread sayeth the lord. And the Roman mob.

Liberal Supply side economics focuses on two parts: securing more of whatever raw materials are in short supply, and promoting capital that reduces the costs of production. The reason government does this is simple: left to its own devices the rentier class will make whatever is rented more scarce, not more abundant. They have no economic incentive to cut their own economic throats.

Then Ian dicusses the Jacobean cycle of economic growth and maturity.
So economies grow through two processes - import replacement and the creation of new work.

They shrink when they lose older work and indeed even without losing old work - because as old work becomes old work it becomes more efficient - you can create more with less and margins and wages, relatively speaking, decrease.

This is Jacobean (Jane Jacobs) economics in brief.

What can you do to help economies conceived of this way?

Well, you can do three things. You can encourage the circumstances that allow new work to be created, you can encourage import replacement and you can discourage others from import replacing your exports. The third is not one that I favour, because it makes it more difficult for the world as a whole to become richer, but it has undeniable advantages and pretending it doesn't exist and doesn't work is the sort of trap that contemporary economists often get into when they discuss free trade and outsourcing. There are disadvantages to it, but it does work.

I'll discuss these three methods of improving economies in a later post but when you're thinking about economic questions it is useful to think about this dynamic - to ask yourself - how can we encourage import replacement, the creation of new products and how can we keep the work in our community for as long as possible?

The question of the future of the United States between these three posts can be summed up into one sentence. Our consumption deficit is a reflection of our energy deficit so the only way to progress as an economy is to come up with an import replacement for the entire set of trade flows based upon energy-deficit-imports. Ian then neatl sums this up in his next post intimating that if we don't we risk falling into a dark age.
Take another analogy – if you win the lottery you have two main choices – to spend it in a great splurge or to invest it so you can be wealthy forever - if you do the second you’ll never live as high as the first, but you’ll live well longer.

Well we’ve spent a lot of it and we’re reaching the point where the amount we can extract from the horde – our monthly payments from the lottery win – cannot sustain our lifestyle. All of the money hasn’t been wasted, by any measure. We’ve built industrial infrastructure and networks of learning institutions and much more besides – institutions and networks that produce wealth. But we haven’t put as much into learning how to create more of what we need – of the Dragon’s gold, of the energy it gives.

And that’s where we are now – with energy profit ratios ready to decline we find ourselves in a situation where more and more of our effort will have to go into getting energy, leaving us with less and less energy to spend on other things – not just the air conditions and lights and heating that we take for granted, but the industrial production that makes our lives of material splendor possible. And as more and more need to work just to obtain energy many activities we do that take great energy may have to be scaled back to take less: which will mean more human energy – more farmers labouring on the Latifundia of the new world (for the family farms are basically gone), few robots and more laborers – all working for less – all doing work that could be done more easily by technology, machines and chemicals – but when energy is hard to come by labor will be substituted. Perhaps your labor.

And so, perhaps, the lights will dim and we may find indeed, that until we come to grips with the fact that the great treasure trove of oil is no longer sufficient to support us as kings that few of us may live lives of energy fed splendor.

This is the challenge before us – like most challenges it is not insurmountable. But also like any real challenge it is not foreordained that we will succeed. For every hero’s story there are a dozen who failed…

This is the fundamental dynamic that the old order has not yet realized. We have already reached the end our leash. The old order trembles and is about to pass away, and Rome is already on the verge of its long tumultuous decline and fall. The day is not tomorrow, it is not a year from now, it is not a decade or a century from now - it is today. This is what our leaders and our populace cannot grasp. We not going to live further on borrowed time, we were already living on borruwed time and our historical debts are going to start being called due. Too long have people focused on the debt itself or on some absolute point of scarcity in oil reserves.

These were games we played with ourselves to prevent ourselves from seeing the truth. Globalization was a means by which we extended the lifetime of the present order by trading capital asset values for energy rent. Globalization was already the second mortgage. Yet within it, it contained the seeds of the very doom of that order because the capital flight to overseas would simultaneously depress native capital markets there and cause those countries to industrialize - therefore increasing the longterm fixed structural demand for energy.

It was contrary to the words of many of its supporters and critics alike, doomed therefore from the start. The end is coming, not because of a shortage of physical oil but because human systems and markets are reactive. They discount and anticipate and change in reponse to conditions and events.

The global economic order is simply finding the trajectory of tragedy unsustainable on a financial and fiscal level and it must begin cannibalizing itself to maintain more crucial parts. That is the stage we are about to enter, economic cannibalization. The reason we must enter them is because after countries industrialzie their fixed energy consumption in structural costs rises dramatically. In situations like this, with scarce resources in order to finance growth one must devote resources to securing energy supplies.

So this is the beginning of the end, because economic systems and societies must adapt to the anticipated changes in the future and thus precipitate them far sooner than would be strictly necessary if it were rationed out. This is sometimes called a gouging or hoarding game, and is a variation of the classic competitive equilibrium or Nash equilibrium. Just like the more well known example of the Prisoner's dillemma, this collective game scenario is being forced into a transition now because of anticipatory collective behavior rather than strict resource depletion.

Of course, anyone who's had to stockpile anything in anticipation of a shortage could have predicted his. Alas unfortunately that has escaped the minds of the economists who think that everyone will simply wait until we truly start running out in order to react. If only that were true and we simply were going to run out of oil, the alternative of a resource rush and economic shifts in coordination with this trend is actually far worse.

The scramble for oil and the economic changes this brings has begun.


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