#196. The price of self-delusion

MYTH & MONEY, TECHNOLOGY & PHYSICS

It can’t be emphasised too often that GDP, which is the preferred measure of economic output and “growth”, has become progressively less meaningful over time.

Essentially, GDP mistakes money for prosperity. It counts the spending of money as economic “activity”, drawing no distinctions between how the money is spent, or whether the money itself has been earned, borrowed, airily promised for the future, or simply created out of the ether.

Worst of all, GDP ignores the deterioration of the cost-value equation which determines how the economy converts the use of energy into material prosperity. It invites us to believe that the economy exists in complete isolation from physical resources such as energy, minerals, plastics, food and water. If we once let ourselves believe that the economy does indeed exist independently of natural resources, ‘growth forever’ becomes a plausible fantasy.

If we follow the logic of GDP, the complete destruction of the Earth’s ability to produce food wouldn’t be too serious, because it would leave the other 94% of the economy intact. If the economy really is independent of material resources, we could colonise Mars by sending nothing more than some starry-eyed pioneers and a printing-press. A more prosaic – as it were, a more ‘down to Earth’ – example would be that survivors of a ship-wreck could live indefinitely in a lifeboat, just so long as their supply of bank-notes didn’t run out.

You might be familiar with how the economy of money has disguised real trends in the underlying economy of material prosperity. In the twenty years preceding the coronavirus crisis, each $1 of reported “growth” in global GDP was the product of nearly $3 of net new borrowing. Even this understates the extent of our self-deception, because it ignores the creation of huge non-debt liabilities. These include both formal commitments and informal assumptions, the latter typified by enormous gaps in promised (but unfunded) pension expectations.

In America, manufacturing accounted for just 0.2% of all reported economic growth between 2000 and 2020. Even adding construction, agriculture and the extractive industries leaves the growth contribution of globally-marketable, ‘hard’-priced activities at only 5%. The remaining 95% of growth came from services.

These services can be important, and valuable, but they can also act as residuals, sinks for liquidity injected into the system. The FIRE (finance, insurance and real estate) sectors alone accounted for almost 30% of all recorded growth – but how much value do we actually derive from moving money around? – with a further 12% coming from government. Both FIRE activities and government spending are obvious conduits for the injection of borrowed or newly-created money into the system.      

The flip-side of this process is the creation of hugely inflated asset “values”, which are products (a) of the abundance (and hence the cheapness) of money, and (b) of the discounting to the present of forward streams of income which reflect expectations wholly detached from any realistic appraisal of the material economy of the future.

What this in turn means is that most asset “values” are no more than a function of our self-delusion about the true size of the economy of today and tomorrow. Many of them, including the aggregate “values” ascribed to equities and property, are purely notional, in that they can never be monetised. Even defined, committed assets – such as debts owed by others – are only as valuable as debtors’ ultimate ability to pay.

The joys of self-delusion

This situation raises two obvious questions. The first is that, as this is collective self-delusion, does it really matter? After all, we’re not trying to measure ourselves against alternative worlds where economic activity is reported more intelligently.

Second, can those of us who understand this situation – and who can, furthermore, put numbers on it – profit from this knowledge?      

The answer to the second question is that yes, we can.

The answer to the first is that, in economics as in so much else, self-delusion does matter. You wouldn’t expect to win a battle by lying to yourself about how many soldiers or warships your enemy had at his disposal. You wouldn’t expect to drive safely by lying to yourself about how much alcohol you’d consumed.

So why would we expect to become more prosperous by deluding ourselves about the size, shape and direction of the economy?

In economics, self-delusion matters because plans based on false information seldom, if ever, turn out well.

Here’s one example of the dangers implicit in economic self-delusion. Between 1999 and 2019, emissions of climate-harming CO² increased by 48%. If we believe official GDP numbers, economic output grew by 110% over that same period. From this, we can infer that economic output per tonne of CO² increased by 42%. Conversely, we could conclude that each dollar of economic activity now produces 30% less CO² than it did twenty years ago.

If we were to believe this, we could also believe that further such progress could, in due course, tame environmental risk, or even eliminate it altogether, without requiring economic sacrifices.

This sort of calculation helps explain why governments’ seemingly sincere (if belated) commitments to environmental reform aren’t accompanied by measures that, in purely physical terms, might appear necessary. We can, we’re told, overcome environmental risk without having fewer cars, limiting engine sizes, insisting on hybrid-only model slates, or rationing air travel.

Much the same applies to the use of energy. Over twenty years in which GDP increased by 110%, consumption of primary energy expanded by only 54%. Accordingly, the economic value created by the use of a single unit of energy seemingly improved by 36%.

The inference is that, in the future, economic output can grow whilst our use of energy decreases. This where the fantasy of “de-coupling” the economy from energy use comes from, and remains persuasive even though experts at the EEB have described the case for de-coupling as “a haystack without a needle”.

It is, after all, surely obvious that literally nothing of any economic value (utility) whatsoever can be produced without the use of energy – so why would we expect to grow the economy without increasing our consumption of energy?

So any theory which postulates indefinite divergence between energy use and economic prosperity affronts the laws of physics. Suggesting that “technology” can somehow over-rule the constraints of physics simply produces ‘self-delusion squared’.     

Cold reality

When we step away from self-deluding convention (and starry-eyed faith in technology), and look behind the fallacy of GDP, very different conclusions emerge.

For starters, stripped of what we can call ‘the credit effect’, world economic output increased by only 40% (rather than by 110%) between 1999 and 2019.

This means that we delivered 5% less economic value for each tonne of CO² emitted, and 9% less economic output from each unit of energy consumed.

Nor is this all. The Energy Cost of Energy (ECoE) is the critical dynamic determining how much economic value we derive from each unit of energy consumed. Driven primarily by fossil fuel depletion, ECoEs have been (and are) rising relentlessly.

If we include ECoE escalation in our calculation, each unit of emitted CO² yielded 10% less material prosperity in 2019 than in 1999, whilst the relationship between prosperity and energy use worsened by 14% over that same period.

The latter point, in particular, is self-evident – if, from any given quantity of energy supplied, more has to be consumed in the supply process, less remains for any other economic purpose.

These inconvenient observations tell us, amongst other things, that we can’t overcome environmental challenges without changing our behaviour, and that we can’t shrink energy consumption without shrinking the economy.

If we factor ECoE into the equation, two further critical points emerge.

First, CO² emissions are a function of the total energy that we use, whilst material prosperity is linked to surplus (ex-ECoE) energy quantities. As ECoEs rise, they load this equation against us

Therefore, a sizeable – and rising – proportion of CO² emissions is tied, not to the economic value that energy use creates, but to the energy that is used only to make energy supply available. We’re never going to combat climate change and ecological degradation effectively until we take this ‘variable geometry’ into account.

Second, realistic appraisal also tells us that we’re nowhere near a point at which we can use renewable energy sources (REs) as a “fix” for the environmental and economic consequences of rising ECoEs.

Transitioning to technologies such as solar and wind power will require huge investment, which has been costed at between $95 and $110 trillion. The money involved isn’t that important in itself. But it corresponds to vast amounts of steel, copper, plastics, lithium and numerous other resource input requirements. Most of these can only be made available through the use of fossil fuels, meaning that the ECoEs of REs are tied to those of oil, gas and coal.

Western societies’ prior growth in prosperity goes into reverse at or below ECoEs of 5%. Less complex EM countries start getting poorer before their ECoEs reach 10%. The latter level of ECoE might, just, be feasible for REs, but the lower level of ECoEs required to maintain (let alone to grow) Western prosperity is a pipe-dream.

Here, once again, we encounter the chimera of technology. The technological progress of the past has enriched us by increasing the efficiency with which we use both energy itself and those other resources whose availability is energy-dependent.

Critically, though, the scope for technological progress is confined within the envelope of the physical characteristics of the resource itself, and, ultimately, is bounded by the laws of thermodynamics.

Simply put, far too many of our expectations for what technology can deliver in the future are based on a fallacious assumption that we can extrapolate technological progress to the point where it trumps physics.

Anyone who believes that to be possible would be better employed writing science fiction, or running a government department. 

Practical implications

If we once free ourselves from the alluring embraces of financial and technological self-delusion, we’re in a position to recognise fundamental challenges that won’t go away just because we bury our heads in the sand.

Our first observation has to be that prosperity consists of those material things – goods and services – whose provision is a function of energy, not of our ability to pour ever more money into the system.

This linkage to energy is particularly important in the provision of essentials, including food and water, housing, health care, education, necessary transport and, of course, energy itself.

Even the most cursory examination tells us that, as prosperity continues to deteriorate in defiance of our economic self-delusion, so the proportion of our prosperity available for all discretionary (non-essential) purposes will diminish.

If, understanding this, you were in government, your forward planning would surely centre on ensuring the availability and affordability of essentials for everyone. This has already become a critical factor, as ever larger numbers are sucked into poorly-paid, insecure forms of employment, just as the cost of necessities continues to rise.

This is where plans for the universal provision of essentials should be front and centre of the policy process, much as – in some countries – universal provision for health care was the flagship objective for an earlier generation of political leaders. 

If you were in business, and applied this same understanding, you wouldn’t be banking on growth. Rather, you’d be working out how best to insulate yourself from a relentless squeeze on discretionary consumption, and how to safeguard your business from the coming technological disillusionment. 

Many people fear that an economic crisis will be brought about by the inflationary consequences of the endless injection of liquidity on the false premise that ‘money equals prosperity’.

They might very well be right.

It’s equally possible, though, that we might see markets brought down by a sudden, dawning recognition that discretionary consumption is destined to contract (as, excluding debt-funded purchasing, it already is); that perpetual growth in future income streams from consumers is a figment of self-delusion; that property prices must fall back into equilibrium with incomes; and that our fascination with technology has been blinding us to the laws of physics as they apply to prosperity, the economy and the environment.