[R-G] [BillTottenWeblog] Where Economics Fails

[Bill Totten]

by John Michael Greer

The Archdruid Report (July 01 2009)

Druid perspectives on nature, culture, and the future of industrial society

It's occurred to me more than once that we might be wise to set aside an
annual weekend to mourn the death of Osiris or Persephone or Bladud the
wind-god or some other divinity, as our pagan ancestors did, or as those
Christians who still take the narratives of their faith seriously do each
year on Good Friday. It might at least put a merciful end to the media's
frantic and macabre efforts to bestow a belated sainthood on each new
member of the dead celebrities' club, no matter how far from sanctity the
trajectory of their lives might have been.

Thus you'd be correct in guessing that I didn't put much time this past
weekend into paying attention to the media furore over the death of
Michael Jackson. I was, instead, busy with my usual research. While tens
of millions of people spent the weekend glued to their TVs reviewing the
catastrophic fall from grace of an undeniably brilliant cultural
phenomenon that achieved unparalleled success, and then was brought down
by a supertanker-sized load of unresolved inner conflicts heated to crisis
by a disastrous mismatch between an extravagant lifestyle and faltering
income - well, I suppose that's a fair description of what I was doing,
too.

Still, the decline and fall of industrial civilization, that troubled and
dysfunctional superstar still wobbling across the historical stage, can't
be tracked that effectively by taking in music videos or soundbite
interviews. Instead, I spent the weekend reading through economics
textbooks. "Thriller" is not exactly the word I'd use to describe these
hefty tomes, but I'd recommend that anyone concerned with the future of
our society ought to read at least one. This is not because current
economic textbooks offer useful guidance to the challenges of our time.
Quite the contrary; the world they describe is as imaginary as Oz, and
rather less relevant to contemporary life. What makes them important is
precisely that so many of the decision makers of our time treat this
fantasy as reality.

Understand current economic thought and you understand most of the
mistakes that are dragging industrial civilization down to ruin. The
Energy Information Administration (EIA), a branch of the US government,
has become infamous in the peak oil scene over the last decade or so for
publishing estimates of future petroleum production that have no
relationship to geological reality. Their methodology, as described in EIA
publications, was simply to estimate probable increases in demand, and
then to assume that increased demand would automatically be met with a
corresponding increase in supply. Quite a few peak oil writers have
suggested some dark conspiracy behind this blithe disregard for the limits
of a finite planet, but it takes only a few minutes' worth of reading to
identify the real culprit as the standard notion of the law of supply and
demand taught in every first-year economics textbook today.

According to this model of the world, the amount of any commodity
available in a free market is controlled by the demand for that commodity.
When consumers want more of a commodity than is available on the market,
and are willing to pay more for it, the price of the commodity goes up;
this provides an economic incentive for producers to produce more of the
commodity, and so the amount of the commodity on the market goes up.
Increased production sets an upper limit on price increases, since
producers competing against one another will cut prices to gain market
share, and the willingness of consumers to pay rising prices is also
limited. Thus, in theory, the production and price of a commodity are set
by a shifting balance between the desire of consumers to buy it and the
desire of producers to make a profit from producing it.

What makes the theory so seductive is that within certain limits, and in
certain circumstances, it works tolerably well. The problem creeps in when
economists lose track of the existence of those limits and circumstances,
and this, to a remarkable degree, is exactly what they have done. To be
fair, they had good reason to do so, because during the three-hundred-year
boom that created the industrial world following the successful harnessing
of fossil fuels, the limits rarely applied and the circumstances were far
more often present than not. Among the most important roots of the current
crisis, in turn, are the hard facts that the limits have begun to come
into play, and the circumstances no longer exist.

Let's start with the obvious. Imagine that a plane full of investment
bankers makes a forced landing in the Pacific close to a desert island.
The island has no food, no water, and no shelter; it's just a bare lump of
rock and sand with a few salt-tolerant grasses on it. As the bankers
struggle ashore from the sinking plane, the need for food, water, and
shelter on that island is going to be considerable, but even if each of
the bankers have a suitcase full of $134 billion dollars in bearer bonds -
like those guys who were caught trying to enter Switzerland a little while
back - that need is going to go unfilled, until and unless a ship arrives
from somewhere else. The lesson here is simple: economics doesn't trump
physical reality.

More generally, the theoretical relationship between supply and demand
functions only when supply is not constrained by factors outside the
economic sphere. The constraints in question can be physical: no matter
how much money you're willing to pay for a perpetual motion machine, for
instance, you can't have one, because the laws of thermodynamics don't
take bribes. They may be political: Nazi Germany had a large demand for
oil from 1943 to 1945, for example, and the Allies had plenty of oil to
sell, but anyone who assumed on that basis that a deal would be cut was in
for a big disappointment. They may be technical: no matter how much you
spend on health care, for instance, sooner or later it's going to fail,
because nobody's yet been able to develop an effective treatment for
death. Economists have come up with various workarounds to deal with
external factors of this sort, some more convincing than others.

Another set of factors that can crumple up the law of supply and demand
and toss it into the wastebasket, though, has received far less attention.
These are constraints that we might as well call "ecological", and they
unfold from the awkward fact that human economic activity is far less
independent of the natural world than economists often try to pretend. The
scale of this dependence is as rarely recognized as it is hard to
overstate. One of the few attempts to quantify it, an attempt to work out
the replacement costs for natural services carried out a few years back by
a team headed by heretical economist Robert Costanza, came up with a
midrange figure equal to around three times the gross domestic product of
all human economic activity on earth.

Out of every dollar of value circulating in the world's economy, in other
words, something like 75 cents were provided by natural processes rather
than human labor. What's more, most if not all of that 75 cents of value
had to be there in advance in order for the production of the other 25
cents to be possible at all. Before you can begin farming, for example,
you need to have arable soil, water, and an adequate growing season, as
well as more specialized natural services such as pollination. These are
nonnegotiable requirements; if you don't have them, you can't farm. The
same is true of every other kind of productive work in the human economy:
nature's contribution comes first, and generally determines how much the
human economy can produce.

It's for this reason that E F Schumacher, the maverick economist whose
ideas are the launching pad for this series of posts, drew a hard
distinction between what he called primary goods and secondary goods.
Secondary goods are the goods and services provided by human labor, the
ordinary subject of economic theory. Primary goods are the goods and
services provided by nature, and they make the production of secondary
goods possible. The difference between the two is very much like the
difference between income and profit in a business: you have to have
income in order to have profit, and if you neglect income while maximizing
your profit, sooner or later you go bust.

A failure to distinguish between primary and secondary goods is at the
root of a great deal of current economic nonsense. It's usually possible,
for example, to substitute one secondary good for another if the supply
runs short or the price gets too high, and for this reason it's a standard
assumption of economics - and one of the foundations of the law of supply
and demand - that consumers can meet their needs equally well with many
different goods. Yet this assumption does not apply to natural goods. In
the world of nature, a different rule - Liebig's law of the minimum -
applies instead: production is limited by the scarcest necessary resource.
Thus if you have a farm and can't get water for your crops, it doesn't
matter if you have excellent soil and all the other requisites of farming;
you can't grow anything.

In certain limited situations, to be sure, it's possible to substitute one
primary good for another - for instance, to use low-grade iron ores such
as taconite when the high-grade ores have been exhausted. Even when this
can be done, though, a law of diminishing returns always applies. You can
get iron out of low-grade ore, but the extraction process is less
efficient and takes much larger inputs of energy. When energy is cheap,
you can ignore this - and this is exactly what happened over the course of
the 20th century, as the iron industry retooled itself to use steadily
lower grades of ore and steadily larger inputs of energy - but that in
itself simply passes costs onto the future, since the fossil fuels that
provided the energy inputs are themselves subject to depletion, and to a
law of diminishing returns. One way or another, the substitution imposes
additional costs without providing any additional economic benefit.

This same rule also applies to every other natural good. Consider the
valuable service provided to the world's economies by the honeybees that
pollinate most nongrain food crops. If we succeed in adding the honeybee
to the already long list of the world's extinct life forms, it would
doubtless be possible to replace their pollination services by other
means, whether that took the form of huge pollinating machines rumbling
across the fields or the simpler and probably more economical approach of
migrant workers using little brushes to wipe pollen from a bag onto the
stamen of every single flower. Note, though, that no farmer in his or her
right mind would hire a thousand laborers with brushes instead of calling
up the local beekeeper and arranging for a few hives to be left in the
fields; substituting some other pollination method for bees would add a
huge additional cost to farming, without yielding any additional benefit.

I've come to think that the unrecognized difference between secondary
goods, which can be readily replaced by other goods without additional
cost, and primary goods, which cannot, is among the most important forces
driving our current crisis. For the last three centuries, the industrial
economies of the world have been using up every primary good that can be
converted into secondary goods at extravagant and steadily increasing
rates. Think of any good or service provided by nature - from topsoil to
oceanic fish stocks, from the pollution-absorbing capacities of rivers to
the storm-buffering properties of wetlands, from breathable air and
drinkable water to the mineral stocks and fossil fuel reserves that keep
the entire system running - and you've just identified something that's
being used up rapidly by industrial societies, with no thought of the
potential costs of substituting something else for it, much less of the
hard fact that nothing we can possibly do can provide a substitute for
some of them once they're gone.

The mismatch between this hopelessly shortsighted approach and the
unforgiving limits of nature is imposing a rising toll of substitution
costs on industrial economies around the world. Of course there are other
factors involved. Still, as I hope to show in a future post, the best
explanation for the "stagflation" that beset economies and baffled
economists in the 1970s was the unrecognized burden of substitution costs
for a range of natural goods depleted or damaged during the previous
decades. Equally, the economic dysfunctions that led central banks around
2002 to flood financial markets with cheap credit - a disastrous decision
that ended up powering the boom and bust that landed us in the current
Great Recession - were driven by mounting substitution costs for another
range of natural goods that had been depleted or overused in the previous
decades of prosperity. As peak oil adds a new round of substitution costs
to those already in play, this same process is likely to have even more
dramatic impacts on the future. 

_____

John Michael Greer has been active in the alternative spirituality
movement for more than 25 years, and is the author of a dozen books,
including The Druidry Handbook (2006) and The Long Descent (2008). He
lives in Ashland, Oregon.

http://thearchdruidreport.blogspot.com/2009/07/where-economics-fails.html


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