#155. The art of dark sky thinking

ECONOMICS, THE ENVIRONMENT AND THE PROBABILITY OF ‘DE-GROWTH’

One of the clichés much loved by business leaders and others is “blue sky thinking”. An implication of this term, it seems to me, is that there’s an infinity of possibility. Although the mainstream press has, in the past, dubbed me “Dr Gloom” and “Terrifying Tim”, I don’t discount the concept of infinite possibility. I’m an incurable optimist – when I’m not looking at the economic outlook, anyway.

However positive you are, though, if you set out on a lengthy expedition, it’s as well to take some wet weather clothing with you, because blue skies can turn dark grey pretty quickly. ‘Hoping for the best but preparing for the worst’ seems a pretty prudent way to think.

Before we address some of the financial, economic and broader issues which might darken our skies, I’d like to draw your attention to an important distinction, which is that ‘situations’ and ‘outcomes’ are different things. ‘Situations’ are circumstances calling for decisions, but, in themselves, they generally contain a multiplicity of possible results. ‘Outcomes’ are determined by the responses made to any particular set of ‘situations’.

This is important, because a lot of what I’m going to discuss here concerns ‘situations’. Many of these look pretty daunting, but the point about a multiplicity of possible ‘outcomes’ remains critical. Bad decisions turn difficult situations into malign outcomes, but wise choices can, at the very least, preclude the worst, and can even produce good outcomes from unpromising situations.

The gloomy non-science

Economics has been called “the gloomy science”. In fact, economics – as currently practised – may or may not be “gloomy”, but it isn’t a “science”. The fundamental flaw with conventional economics is that it assumes that the economy is a financial system, to be measured in dollars, pounds, euros and yen.

This, in reality, is a huge misconception. Throughout history, systems of money have come and gone. A collector might well buy a Roman coin from you, but you couldn’t use it in a café or a shop.  Money is simply a human artefact, often of temporary duration, which we can create or destroy at will.

The purpose of money is the facilitation of exchange, something more convenient than barter. Its other often-claimed functions (as “a store of value” and a “unit of account”) are flawed at best. The “store of value” concept is particularly unconvincing. If somebody in a Western country dug up some banknotes buried in the garden by his or her great-grandmother, their purchasing power would be dramatically lower than when the biscuit-tin containing them was interred between the cabbages and the carrots. Measured using the broad-basis GDP deflator, the US dollar has lost 62% of its purchasing power since 1980 alone, and the pound has shed 71% of its value. Moreover, many countries change their notes and coins at frequent intervals, invalidating older versions.

Money does have important characteristics – which we’ll come to – but it’s not in any sense coterminous with a ‘real’ economy that consists of goods and services. All of these are products of the use of energy. Once you grasp this fundamental point, a ‘science’ of economics becomes a possibility, but as a branch of the laws of thermodynamics, and not, as now, as ‘the study of money’.

The energy fundamentals

As regular readers will know, whenever energy is accessed, some of that energy is always consumed in the access process. This divides the totality of energy supply into two streams – the consumed component is known here as ECoE (the Energy Cost of Energy), and the remainder is surplus energy. Because this surplus energy powers all forms of economic activity other than the supply of energy itself, it is the determinant of prosperity.

The SEEDS model calculates that, over the last twenty years, global trend ECoE has more than doubled, from 3.6% in 1998 to 7.9% last year. That’s already taken a huge bite out of our ability to grow our prosperity, and there’s no likelihood of ECoE levelling out in the foreseeable future, let alone turning back downwards.

The ECoEs of renewables are falling, just as those of fossil fuels are rising exponentially. This is a topic that we’ve discussed before, and will undoubtedly return to in the future, but it seems unlikely that a full transition to renewables, utterly vital though it is, is going to stabilise overall ECoE at much below about 10%. For context, back in the 1960s, when real economic growth was robust (and when petroleum consumption was growing by as much as 8% annually, whilst car ownership was expanding rapidly), world trend ECoE was less than 2%.

There are two reasons – one obvious, one perhaps less so – why an understanding of ECoE is critical to the environmental debate.

Obviously, if we continue to tie our economic fortunes to fossil fuels, the relentless rise in their ECoEs is going to carry on making us poorer, so there’s a compelling economic (as well as environmental) case for transition to renewables.

Less obviously, whilst prosperity is a function of surplus (aggregate less-ECoE) energy, climate-harming emissions are tied to total (surplus plus ECoE) energy. Essentially, we need to reduce our emissions from fossil fuels at a rate which at least matches the rate at which their ECoEs are rising if we’re to stand any chance at all of overcoming climate risk.

It’s a dispiriting thought that, whilst energy-based economics could make a powerful contribution to the case for environmental action, conventional, money-fixated economics can only interact negatively, by telling us how much it’s going to “cost”. Unfortunately, mainstream economics can’t really tell us the cost of not transitioning.

These “costs”, to be sure, are dauntingly large numbers. IRENA – the International Renewable Energy Agency – has costed transition at between $95 trillion and $110tn. These equate to between 619 and 721 Apollo programmes at the current-equivalent cost ($153bn) of putting a man on the Moon.

Moreover, the Americans of the 1960s had a choice about whether or not to fund a space programme. In economic as well as in environmental terms, there is no choice at all about our imperative need to transition.

The invalidation of futurity

The gigantic costs that energy transition involve bring us back to money, where we need to note something that couldn’t really be done with barter, but is well facilitated by money. That concept is futurity.

Time itself has always formed part of economic transactions, and this was the case even before the invention of the first efficient heat-engine enabled us to tap the energy wealth of fossil fuels. When someone bought, say, a table, he or she was paying for the labour (which, of course, is energy) that had gone into making it. Hiring someone to plough a field was a payment for labour in the present, and engaging someone to build a barn was payment for labour in the future.

But futurity is something different. When someone invests, he or she is looking to the future, hoping that income from the investment, or its future saleable value, will exceed the initial outlay. When an insurance policy is agreed, both parties have in mind the likelihood, and possible cost, of some future eventuality. Perhaps most importantly of all, loan transactions make a lot of assumptions about the future in which the loan, and interest, are to be repaid. Very much the same applies to saving for a pension.

All of these transactions can make a positive contribution to the effective functioning of the economy. Vitally, though, they require making assumptions about conditions at some future date. To a large extent, these assumptions – which, collectively, form a consensus – are based on prior experience. To this extent, decisions taken about futurity are only as good as the consensus on which they are based.

Imagine that you’re an insurer, issuing a policy on a car. Historically, this type of car, and this category of driver, is likely to be involved in an accident once in ten years, so the policy is priced accordingly, remembering that competitor insurance companies are likely to be working on a very similar basis of calculation. Then, though, these cars start crashing, not once every ten years, but once in every three. You’ll lose money, because your futurity assumption has been invalidated.

This is a simple example, with corollaries in any transaction involving futurity. The danger arises when prior experience ceases to be a valid guide to the future.

A good real-world example involves the provision of pensions. Prior to the 2008 global financial crisis (GFC), historic long-run returns on American bonds and equities averaged 3.6% and 8.6%, respectively. Now, though, forward calculations need to be based, according to the World Economic Forum, on returns of only 3.45% for equities, and just 0.15% for bonds. Critically, this doesn’t just apply to funds invested after the fall in rates – it also cripples forward returns on capital accumulated before rates of return collapsed.

This, says the WEF, has helped created shortfalls so large that they amount to a “global pension timebomb”. Since, according to my calculations, a person investing 10% of his or her income in a pension fund before the GFC now needs to raise that to about 27% to get the same outcome – a percentage not remotely affordable for most people – we can almost say that private pension provision worldwide has been rendered inoperable by post-2008 monetary policy.

If my energy-based interpretation of the outlook for prosperity is correct – and I’d contend, simply, that its logic keeps getting more and more corroboration from events – then the entire basis of ‘consensus futurity’ has been invalidated. SEEDS shows prosperity growth petering out, not in the future, but now, and over a period which began roughly twenty years ago.

This invalidated the futurity consensus used during the massive issuance of debt before 2008, and, equally, destroys the assumptions on which subsequent monetary adventurism has been based.

Slow or negative growth – something which invalidates any projection based on pre-2000 experience – means that “secular stagnation” (or whatever euphemism you care to use) isn’t something that the economy will “grow out of”, much as youngsters grow out of childhood ailments. It’s the ‘new normal’, though it’s not the kind of thing that anyone is going to recognize as ‘normal’.

This, sooner or later, can be expected to cause a financial crash on a scale much larger than 2008, and this event (‘GFC II’) is going to hit, not just the banks, as in GFC I, but the financial system, and the very validity of fiat currencies.

Put another way, the ‘real’ and the ‘financial’ economies have moved so far apart that the latter is destined to topple over into the gap.

And this, remember, is the same financial system that needs to find the equivalent of more than 700 Apollo space programmes to finance energy transition.

I hope I’m wrong about financial crash risk, but I can see only one possible way out of the gigantic commitments – debt, pensions and much more – that we have made to a future that isn’t going to be what we thought it was going to be. The theme tune for this could be a song by the late, great Mickey Newbury – “The future’s not what it used to be”.

That only possible way out is the deliberate triggering of inflation. This would allow borrowers to ‘soft default’ their way out of unaffordable debt, ‘repaying’ lenders but in greatly devalued money. But it’s a medicine whose economic side-effects are at least as bad as the disease. High inflation has killed more currencies than any other cause.

‘De-coupling’ fiction and ‘de-growth’ fact

Rather than going into the implications of a financial crisis dwarfing that of 2008, my aim here is to look at the broader economic and environmental issues both before and after GFC II. Optimistically, one consequence of that event could be a general reappraisal of our situation – and this, of course, is where the logic of choices determining the ‘outcomes’ of ‘situations’ becomes all-important.

One set of possible choices is to try to recreate the status quo ante, but a more positive interpretation is that we will finally be forced to face a reality that, hitherto, few have understood, and fewer still have been prepared to confront.

Already, though, here have been some encouraging exceptions. In Britain, for example, chief environmental scientist Professor Sir Ian Boyd, has said recently that environmental objectives can be achieved only if people can be persuaded to move away from consumption.

This followed a report from a committee of legislators which concluded that, “[I]n the long-term, widespread personal vehicle ownership does not appear to be compatible with significant decarbonisation”. The committee said that the government should “aim to reduce the number of vehicles required”, promoting public transport and making it cheaper than car ownership. (In passing, it’s regrettable that the committee also advocated the inclusion of hybrids in the future ban on the sale of petrol- and diesel-powered cars, when it could instead have called for a near-term all-hybrids policy, and a limit on engine sizes).

The situation to be faced can be summarised as follows. Our obsession with “growth” has led us into behaviours which are destructive, not just of our environment and ecology, but in ways that we might term ‘social’, ‘political’ and ‘behavioural’. Now, though, energy-based interpretation suggests that the scope for further growth has ceased to exist. This compels us to change our thinking about the economy.

Of course, I don’t doubt that, even in extremis, a consensus based on conventional financial interpretation of the economy will express outright denial over this, and will come up with yet more hare-brained schemes to follow on from failed credit and monetary adventurism. These may well be attempted but, of course, they won’t work.

The fundamentals are that the surplus energy from fossil fuels which, hitherto, has driven economic growth is being squeezed, from two directions. Whilst the trend ECoE of fossil fuels is rising, our ability to try to counter this by increasing aggregate (pre-ECoE) supply is nearing its limits. The petroleum industry may indeed be guilty of having “cried wolf” in the past over the sorts of prices it needs to overcome depletion, but the reality of ECoE – especially where oil is concerned – suggests that the economics of the industry in many parts of the world really are in trouble. We can anticipate higher production from at least two OPEC countries – Iraq and Iran – and might extend this hope to Russia, though the costs of Russian production are far from encouraging. But US shale production alone is barely economic (if that), and has required, from the outset, subsidy, from optimistic investors and very insouciant lenders.

Whether ‘peak oil’ is brought about by cost-based supply constraint, or by the diminishing ability of customers to purchase petroleum, is something of a secondary consideration. But we do need to note that about 97% of all transport is powered by oil, with electric railways the only sizeable exception.

At the same time, we should dismiss the idea that we can somehow “decouple” the economy from energy. Fortunately, a quite superb recent report from the European Environmental Bureau (EEB) has debunked the concept of “decoupling” so comprehensively that we can defer detailed consideration to a later discussion.

“Our finding is clear”, the EEB report concludes – “the decoupling literature is a haystack without a needle”.

There – political leaders please note – goes your cherished ambition to deliver “sustainable growth”. ‘Sustainable’ is something to which we can and must aspire. But “growth” is not.

Transition is vital – but at what scale?

This, of course, takes us back to transition. I’ve aimed to leave nobody in any doubt about my belief in the imperative need to make this transition. I share the experts’ concern about climate change, and am horrified by many broader issues, such as the loss of habitats and species.

All of these consequences are a price far too high to pay for an obsession, rooted in quite recent history, with ‘growth at all costs’.

But I do question, very seriously indeed, whether we can wholly replace today’s use of fossil fuels with renewables, let alone use them to increase the aggregate supply of primary energy to the economy.

Financially, a capital requirement of $95tn to $110tn, even spread over thirty years, suggests that we need to be investing an average of about $3,400bn annually, against which actual spending (last year, $304bn) simply doesn’t cut it. Unit costs will continue to decrease. But so too – in a world with diminishing prosperity, and with a near-manic prioritization of immediate consumption over long-term investment – will our capacity for investment.

Then there’s the sheer volumetric scale of what needs to be done. In 2018, the world consumed more than 11,740 million tonnes of oil equivalent (mmtoe) of oil, gas and coal. Replacing that, again over thirty years, requires annual additions of output from renewables averaging 390 mmtoe, from a current base of 561 mmtoe. Last year’s actual increase was only 71 mmtoe, and the rate of capacity expansion has stalled. Even the 390 mmtoe number assumes no further increases in energy supply.

The third consideration, in addition to capital requirements and volumetric scale, is resources. Transition to full like-for-like replacement of fossil fuels would require vast material inputs, most obviously steel, copper and plastics. Ironically, the supply of these inputs currently relies very heavily indeed on the use of fossil fuels.

Back in the 1960s, the television series Thunderbirds looked ahead to a near future in which nearly everything – from cars and trucks to aeroplanes, ships, space rockets and, perhaps, even the humble lawnmower – was going to be nuclear-powered. Some of today’s portrayals of the future as a bigger, cleaner, glossier version of today look like similar techno-dreaming.

The idea that we’ll be driving just as many (or more) cars as we do today (except that they’ll be electric), and that we’ll be taking just as many flights (but in aeroplanes powered by batteries) seems pretty implausible.

Both economic and environmental reality suggest a need to embrace the concept of de-growth. The trick will be so to manage it that an economy that is smaller in size is also more in tune with human needs.