HOW WE CAN MEASURE PROSPERITY
Because almost every aspect of our lives is shaped by material prosperity, anyone wishing to understand issues such as government, business, finance and the environment needs to make a choice between two conflicting interpretations.
One of these is that the economy is a purely financial system which, if it were true, would mean that our economic fate is in our own hands – our ability to control the human artefact of money would enable us to achieve growth in perpetuity.
The other is that, on the contrary, money simply codifies prosperity, which itself is determined by the use of energy. This interpretation ties our circumstances and prospects to the cost and availability of energy, and explains growth in prosperity since the late 1700s as a function of the availability of cheap and abundant energy from coal, oil and gas.
The critical factor in the energy equation is the relationship between the supply of energy and the cost (expressed in energy terms) of putting energy to use. The cost element is known here as ECoE (the Energy Cost of Energy), which has been rising relentlessly over an extended period.
This means that ECoE is the ‘missing component’ in conventional economic interpretation. Whilst ECoE remained low, its omission mattered much less than it does now. This is why conventional, money-based economic modelling appeared to work pretty well, until ECoE became big enough to introduce progressive invalidation into economic models. This process can be traced to the 1990s, when conventional interpretation noticed – but could not explain – a phenomenon then labelled “secular stagnation”.
If economics should indeed be understood in energy terms, the possibility exists that we can model the economy on this basis, expressing in financial ‘language’ findings derived from energy-based interpretation. From the outset, this has been the aim of the SEEDS economic model. The alternatives to this approach are (a) to persist with money-based models which we know are becoming progressively less effective, or (b) to give up on modelling altogether, and ‘to blindly go’ into a future that we cannot understand.
SEEDS has now reached the point at which we can ‘map’ the economy on a comprehensive basis, starting with a top-level calibration of prosperity which shows that rising ECoEs are impairing the material value of energy, and will in due course reduce energy availability as well.
Starting from this top-level calibration, SEEDS goes on to map out the ways in which, as we get poorer, our scope for discretionary (non-essential) consumption will decrease, whilst economic systems will become less complex through processes including simplification (of products and processes) and de-layering.
As involuntary “de-growth” sets in, a financial system based on the false premise of ‘perpetual growth’ will fail, resulting in falls in asset values and a worsening inability to meet prior financial commitments. If we persist in using monetary manipulation in an effort to defy economic gravity, the result will be a degradation in the quality and viability of current monetary systems.
As personal prosperity shrinks, public priorities will switch towards a greater emphasis on matters of economic well-being, including the choices that we make about the use of prosperity, and its distribution as wealth and incomes.
The aim here is to explain the mapping process and set out its findings. This article starts the process by looking at how prosperity is calibrated, and the trends to be anticipated in aggregate and per-person prosperity.
A second article will evaluate what this will mean in various areas, including finance, business and government. It might then be desirable to examine how we might best adapt our systems to accommodate changes in an economy that is turning out not be a money-driven ‘perpetual growth machine’ after all.
PART ONE: CALIBRATING PROSPERITY
It’s an observable reality that the dramatic expansion in population numbers and economic activity since the start of the Industrial Age in the late 1700s has been a product of access to cheap and abundant energy from coal, oil and natural gas.
This has been reflected in a correspondingly rapid rise in energy use per capita. This metric has expanded along an exponential progression that has been checked only twice – once during the Great Depression of the 1930s, and again during the oil crises of the 1970s. Even these interruptions to this progression turned out to be temporary, though both were associated with severe economic hardship and financial dislocation.
Importantly, neither of these events was a function of changes in energy fundamentals. Rather, both were consequences of mismanagement within a physical (energy) context which remained favourable for growth. Preceding financial excess was at the root of the Great Depression, whilst the crises of the 1970s resulted from a breakdown in the relationship between producers and consumers of oil.
In recent times, belated recognition of the threat posed to the environment by the use of fossil fuels has shifted the focus towards ambitions for dramatic increases in renewable sources of energy (REs). But the assumption has remained that we will nevertheless be using more energy, not less – and, very probably, more fossil fuels – for the foreseeable future.
The consensus expectation, as of late-2019, was that, despite an assumed rapid increase in the supply of REs, the world would nevertheless be using about 14% more fossil fuels in 2040 than it used in 2018, with the consumption of oil increasing by 10-12%, and no overall fall in the use of coal.
These assumptions were reflected in the depressing conclusion that emissions of CO² would continue to grow, with massive investment in non-fossil alternatives doing nothing more than blunt the rate of emissions increase.
The flip-side of these projections was the almost unchallenged faith that continued to be placed in a ‘future of more’ – for example, it was assumed that, by 2040, there would be an increase of about 75% in the world’s vehicle fleet, and that passenger flights would have expanded by about 90%. Automation – as a use of energy – would continue, as would the consumption of non-essential (discretionary) goods and services.
Government, business and financial planning remains predicated on this assumption of never-ending economic expansion.
Fundamentally, none of these assumptions has been re-thought because of the coronavirus crisis. Expectations for the future ‘mix’ of energy supply may have changed since late-2019, but the consensus view seems to remain that, after the energy consumption hiatus caused by the covid crisis, the future will still be shaped by a continuing expansion in the use of primary energy. It still seems to be assumed that there will be no overall reduction in the use of fossil fuels, at least until the middle years of the century. Needless to say, faith in a ‘future of more’ remains unshaken.
Some commentators may opine that the fossil fuel industries are ‘finished’, but realistic assessments of the rates at which RE capacities are capable of expanding do not support a view that REs can expand rapidly enough to replace much of our current reliance on oil, gas and coal.
The problem with all of the consensus forecasts seems to be that forward energy use projections are a function of economic assumptions. Thus, if the economy is assumed to be X% bigger by, say, 2040, then its energy needs will have risen by Y%, and the deduction of non-fossil supply projections for 2040 leaves our need for fossil fuels in that year as a residual.
This, of course, is to take things in the wrong order. What we should be doing is assessing the future energy outlook, and only then asking ourselves how much economic activity the projected level (and cost) of energy supply is likely to support.
For this reason, SEEDS no longer uses consensus-based projections for future energy supply. The SEEDS alternative scenario sees the world having 8% less fossil fuel energy available in 2040 than was used in 2018. The inclusion of assumed rapid increases in contributions from non-fossil sources still leaves total primary energy supply no higher in 2040 than it was in 2018. Even this scenario might turn out to have been over-optimistic.
This in turn means that primary energy use per person has now started to decline. Something along these lines happened during the 1930s and the 1970s, but neither was more than a temporary hiatus in a continuing upwards trend.
ECoE and surplus energy
For the purposes of economic modelling, the aggregate amount of energy available at any given time needs to calibrated to incorporate changes in the energy cost of accessing that energy. The principle involved is that, whenever energy is accessed for our use, some of that energy is always consumed in the access process, meaning that it is not available for any other economic purpose. This ‘consumed in access’ component is known here as ECoE (the Energy Cost of Energy).
The processes which drive changes in the level of ECoE are reasonably well understood. In the early stages of the use of any type of energy, ECoEs are driven downwards by a combination of geographic reach and economies of scale. Once these drivers are exhausted, depletion kicks in, driving ECoEs back upwards.
Technology acts to reinforce the downwards pressures exerted by reach and scale, and mitigates the upwards cost pressure of depletion. But the scope of technology is limited by the physical characteristics of the energy resource, such that no amount of technological progress can, for instance, cancel out the effects of depletion.
Thanks to scale and reach, assisted by progress in technology, the ECoEs of fossil fuels fell steadily for most of the Industrial Age until they reached a nadir that occurred during the twenty years after 1945. This meant that, until this nadir arrived, we benefited both from increasing total energy supplies and from falling ECoEs. This is to say that ‘surplus’ (ex-ECoE) energy availability increased more rapidly than the totality of supply.
For a long time now, though, the ECoEs of oil, gas and coal have been rising, a function of depletion, only partially mitigated by technology. With fossil fuels still accounting for more than four-fifths of all primary energy consumption, this has meant that overall ECoE, too, has risen relentlessly. This overall trend, as calibrated by SEEDS, is that ECoE rose from 1.8% in 1980 to 4.2% in 2000 and 6.4% in 2010, with the number for 2020 put at 9.0% and an ECoE of 11.6% projected for 2030.
This interpretation, taken together with volume projections – themselves heavily influenced by ECoE cost trends – suggest that the decline in total energy use per person will be compounded by a still-faster fall in surplus energy supply per person. This, incidentally, means that surplus energy, both in aggregate and per capita, would fall even if the over-optimistic consensus view on aggregate energy supply turned out to be correct.
The great hope, of course, has to be that the downwards trend in the ECoEs of REs will continue indefinitely, eventually driving overall ECoEs back downwards. This is unlikely to happen, not least because expansion in RE capacity continues to depend on inputs made available by the use of resources whose availability relies on the use of fossil fuels. We cannot – yet, anyway – build wind turbines or solar panels using only the energy that wind and solar power generation can provide.
Though the ECoEs of REs are indeed at or near the point of crossover with those of fossil fuels, this is really a function of the continuing, relentless rise in the costs of accessing oil, gas and coal.
It is, of course, a truism that equal calorific quantities of energy from different sources have different characteristics. Energy from petroleum, for instance, is ideally suited for use in cars and commercial vehicles, whereas wind and solar energy are better suited to transport systems like trains and trams. Public transport systems, powered directly, can greatly reduce our reliance on the insertion of batteries into the sequence between the supply and use of electricity.
This, essentially, is a management issue, in which trying to drive petroleum-optimised vehicles with wind or solar electricity can be likened to trying to propel a sailing ship using steam directed at its sails.
With the role of prosperity-determining surplus energy understood, the next stage in energy-based mapping of the economy is to connect this to the financial calibrations through which, by convention, economic debate is presented.
Unfortunately, the conventionally favoured metric of GDP is unsuited to this purpose, essentially because rapid expansion in debt (and in other liabilities) creates a sympathetic (and artificial) increase in apparent GDP.
Regular readers will be familiar with the ‘wedge’ interpretation set out in the next set of charts. Between 1999 and 2019, reported GDP increased by $66tn (PPP*) whilst debt expanded by $197tn, meaning that each dollar of reported “growth” was accompanied by $3 of net new debt. Over a period in which GDP grew at an average rate of 3.2%, annual borrowing averaged 9.6% of GDP.
With these credit distortions understood and excluded, the rate of growth falls from the reported 3.2% to just 1.4% on an underlying basis. The calibration of underlying or ‘clean’ output (C-GDP) reveals that the insertion of a ‘wedge’ between debt and C-GDP is reflected in the emergence of a corresponding wedge between reported (GDP) and underlying (C-GDP) economic output.
This in turn means that we are deluding ourselves, not just about the real level of economic output but also about the various ratios and distributions based upon that metric.
Ultimately, the basis of any effective system for interpreting and modelling the economy must be the identification of prosperity, a concept which can then be used as the denominator in a host of important equations. The SEEDS model accomplishes this by identifying C-GDP and then deducting trend ECoE.
C-GDP defines economic output, but recognition of the role of ECoE means that this output is not, in its entirety, ’free and clear’. Output, measured as C-GDP, is the financial counterpart of the aggregate energy available for use. But a proportion of this energy value – and, consequently, a corresponding proportion of economic output – is required for the supply of energy itself, and is not, therefore, available for any other economic purpose. Accordingly, trend ECoE is deducted from C-GDP output to arrive at a calibration of prosperity. This, of course, can be expressed either in aggregate or in per capita amounts.
Before going further, we can note that an equation involving four components defines material well-being calibrated as prosperity. First, we need to know the quantity (Q) of energy available for economic use. Second, we need to identify the conversion efficiency (CE) with which this energy is turned into economic value (O).
Third, we need to deduct ECoE to know how much of this economic value is ‘free and clear’ for use in all economic purposes other than the supply of energy itself. Fourth, the division of the resulting aggregate prosperity (P) by the population number (N) tells us the prosperity of the average person in the economy.
At the top level, this equation reveals the onset of a deterioration in global prosperity per person. Energy quantity growth (Q) is slowing, and the best we can expect for conversion efficiency (CE) is somewhere between static and gradually eroding. ECoEs are continuing to rise, and the number of people between whom prosperity (P) is shared continues to increase.
A summary of projected trends in prosperity per person is set out in the following table.
A critical determinant which emerges from this equation is the existence of a direct correlation between ECoE and prosperity per capita. In the United States, prosperity per person turned down after 2000, when American trend ECoE was 4.5%. The coronavirus crisis seems to have brought forwards the inflection-point in China to 2019, when the country’s trend ECoE was 8.2%.
Broad observation across the thirty countries covered by SEEDS indicates that complexity determines the level of ECoE at which prosperity per capita turns downwards. In the sixteen advanced economies group analysed by the model (AE-16), the inflection point occurs at ECoEs of between 3.5% and 5%. The equivalent range for the fourteen EM (emerging market) countries (EM-14) runs from 8% to 10%.
This has meant that EM countries’ prosperity has continued to improve as that of the AE-16 group has turned down. This in turn has meant that global, all-countries prosperity has been on a long plateau, with continued progress in some countries offsetting deterioration in others.
Now, though, the model indicates that the plateau has ended, meaning that, from here on, the world’s average person gets poorer.
These top-down findings are a good point at which to conclude the first part of this explanation of the energy-based mapping of the economy of which SEEDS is now capable. In Part Two, we shall follow some of its implications, looking at assets and liabilities, the outlook for businesses and the challenges facing government.
* Global aggregation and international comparison require the conversion of other currencies into dollars. One way of doing this is to use market exchange rates. The other is to convert on the basis of purchasing power parity (PPP).
Except where otherwise noted, SEEDS uses the PPP convention. Where circumstances make market conversion preferable, the annotation ‘MKT’ is used.