#239: Life after liberalism?

THE CESSATION OF GROWTH CHANGES EVERYTHING

There can be no doubt at all that the global economy is in very bad shape. For some, this portends a general “collapse”. This, however, presupposes that we don’t adapt to new conditions, and that we don’t learn from past mistakes. We have a pretty solid history of doing exactly that, even if we only arrive at the right conclusions after trying all of the wrong ones first.

Of course, to adapt to new conditions, and to learn from mistakes, we need to know what these conditions and these mistakes actually are. Conventional interpretations of economics are failing us through an inability to provide the information required for this understanding.

The view set out here is that we do have a greatly enhanced understanding of how the economy works. Orthodox economics may continue to cling to precepts first laid down in the eighteenth century – essentially, that the economy can be understood in terms of money alone – but broader thought has moved on, spurred by energy shortages, by environmental concerns, and by recognition that the ‘perpetual growth’ promised by the orthodoxy simply isn’t happening.

The big challenges now are two-fold. The first is to adapt society to an economy that, having ceased to grow, has now started to contract. The second is to redesign a financial system that is exposed to failure because it has been wholly predicated on the fallacious notion that the economy can expand in perpetuity.

Politics isn’t entirely a matter of economics, but it’s very nearly so. Socialist, social democratic, conservative, ultra-‘liberal’ and all other strands of political thought are all founded on particular conceptions of the economy. As Robert Lowe (1811-92) put it, politics is a contest “between those who have – to keep what they have got; and those who have not – to get it”.

Political parties might be described as ‘combinations of economic thought and self-interest’. In practical terms, what this means is that the invalidation of a party’s economic proposition reduces its platform to one of pure self-interest.

For example, politicians in the USSR might have been sincere believers in Marxist-Leninist economic dogma, but they would also have been cognisant of the privileges of Soviet leaders and officials. Likewise, even purist believers in extreme ‘liberal’ economics are not uninfluenced by the rewards that this ideology can provide, not just to its leaders but to its supporters as well.

Contemporary economic liberalism is founded on the proposition that unfettered markets best serve the public interest. As a principle, this is soundly rooted in Adam Smith. Economic liberalism is not threatened by an invalidation of the principle of competition.

But it is challenged on two other fronts.

One of these is the presumption that the economy can be understood in entirely financial terms, and is, on this basis, capable of delivering growth in perpetuity. The unravelling of classical, ‘money only, growth forever’ economics will thus be detrimental to the “liberal” economic proposition.

The other is the claim that, if “liberalism” isn’t very good at delivering equality, at least it compensates for this deficiency by delivering “growth”. As prior growth ceases and goes into reverse, this plank of the liberal economic platform will fail. The public will be left with ‘the inequality without the growth’.

We don’t yet know what political ideas and systems will emerge as we endeavour to address a contracting economy and a failing financial system. But we can be pretty sure that the future ascendancy won’t endorse economic ‘liberalism’.

In other words, a ‘post-growth’ economy will produce ‘post-liberal’ politics.

The duality of prosperity and money

A critical point about economic interpretation, as it’s understood here, is the conceptual distinction that needs to be drawn between two economies. One of these is the ‘real’ economy of goods and services. The other is the ‘financial’ economy of money and credit.

The principles underpinning this interpretation are simplicity itself. The first is that the economy which provides products and services is a material system, determined by the use of energy.

The second is that money, having no intrinsic worth, commands value only as a ‘claim’ on the output of the material economy.  

With this distinction drawn, a realistic appraisal is that, whilst the material economy of energy has ceased growing, the proxy economy of money has carried on expanding. This implies that, whilst economic deterioration may be manageable, the financial system is no longer fit for purpose, and will need to be re-designed.

Much the same applies to economic and political thinking. Extreme collectivism has been tried, and has failed. Extreme liberalism has now reached its equivalent point of failure.

Both of these failed extremes have been rooted in a particular view of the role of the market. For collectivists, the market doesn’t matter, and the economy can be operated on the basis of central diktat. This set of ideas failed in the Soviet Union and, prior to the Deng reforms, was failing in China.

The other extreme is the assertion that the market is all-important. Theoretical liberalism worships the market in much the same way that theocracies worship a deity – that is to say, extreme liberalism isn’t open to doubt about the principle that the market is all-important.

On the shoulders of giants

The irony here is that economic ideologies are variously rooted in things that great thinkers – such as Smith, Marx and Keynes – didn’t actually say. Marx, at least, knew as much, famously stating that “I am not a Marxist”.

The fallacies based on a misreading of Marx are not our priority here, because the unfolding event now is the failure of a ‘liberal’ economic ideology which claims to be based on the precepts of Adam Smith.

In this narrative, Smith is portrayed as a worshipper of the market, an advocate of uncontrolled market operation and an opponent of ‘the public sector’.

The snag is that this caricature misrepresents what Smith actually said.

Smith’s great understanding is that the market operates as a ‘hidden hand’, advancing the general good through the pursuit of individual aims. The public is provided with bread, for instance, not through the altruism of bakers, but through their striving to make a profit.

That is, the operative process driving economic betterment is competition. This remains a wholly valid conclusion.

From this, though, it follows that competition must be allowed to operate unfettered, a principle that we might summarize as markets that are ‘free and fair’.

For Smith, state intervention wasn’t at the top of the list of potential fetters to the beneficial working of the market. This is hardly surprising, because Smith wrote at a time when the state was very small indeed, and when the term ‘the public sector’ was not yet in use.  

Rather, the potential threats to free and fair competition existed, for Smith, in the realm of manipulation. The same competitive incentive that could promote the effective operation of the economy could also lead to self-serving distortion. Smith’s strongest invective is saved, not for the state, but for those market participants who strive to impose distortions, such as monopolies and oligopolies.

In short, Smith did not believe that markets could be free and fair if they were left to their own devices.

In modern terminology, we can state that Smith was an opponent of excessive market concentration and an advocate of effective regulation. Along the lines of “I am not a Marxist”, Smith might, had he lived long enough, have said that ‘I am not a deregulator’.

Effective markets are orderly, not a caveat emptor free-for-all, and they won’t stay free, fair or effective without supervision. The state is the only plausible provider of this supervision.

The realm of the material

The other thing to note about Adam Smith is that he was writing in a pre-industrial society. His master-work, The Wealth of Nations, was published in the same year (1776) as James Watt’s completion of the first truly efficient steam engine.

At the dawn of the industrial age, it would have been impossible for Smith – or Watt – to conceive the concept of resource limits as these are understood today. Where scarcity was recognized, it was scarcity of land, and of labour. The concept of energy or environmental limits could not be understood until we started to experience both.

Explaining the critical importance of the market under conditions in which the concepts of resource and environmental scarcity did not exist, Smith can be said to have laid the foundations for an economic orthodoxy which portrays the economy as a wholly financial system.

A big part of our problem today is that conventional economics hasn’t moved on from a perception which, after all, was laid down 250 years ago.

In numerous other fields of thought, ideas have moved on from precepts which have been challenged by subsequent events. Life scientists and technologists don’t insist on the observance of statements made in 1776.

But economics hasn’t moved with the times. The presumption remains that the economy can be understood in financial terms alone.

Unlike Adam Smith, we live in an energy-intensive economy. Aside from a few mills driven by water or wind, the dominant source of energy in his times was human and animal labour. This had been the case for millennia, so Smith can hardly be blamed for not knowing that this was about to change.

Today, we know that the supply of products and services is a function of the use of energy. If we didn’t know this before, recognition has been forced upon us by events, not just by the current energy crisis but by the events of the 1970s as well.

Even before the oil embargoes of the seventies, the centrality of energy to economic processes should have been obvious. For example, energy deficiencies drove Imperial Japan to fight a war with the United States, and American resource supremacy ensured the outcome. The aircraft, ships and tanks that helped win the war could not have been supplied without the then resource wealth of the American petroleum industry.

Conclusions about the critical importance of energy were expounded as long ago as 1957, by Admiral Hyman G. Rickover, USN, the “father of the nuclear submarine”. One of his observations should resonate particularly with anyone who understands the economy as a surplus energy system:

“Possession of surplus energy is, of course, a requisite for any kind of civilization, for if man possesses merely the energy of his own muscles, he must expend all his strength – mental and physical – to obtain the bare necessities of life” (my emphasis).

The emergence of constraints

We now know, then – as Smith could not – that the economy is a surplus energy system. We also know about the environmental issues associated with the use of energy. This knowledge should enable us to understand that all other materials – including food, minerals, plastics and even water – are products of the energy used to supply them.

Rather than adopt these realities – and to accept, as Admiral Rickover said, that “the Earth is finite” – orthodox economics has jumped through hoops in its insistence that infinite growth is made possible by the wholly financial character of the economy.

The principal plank of this platform is the assertion that demand creates supply – if sufficient financial incentives are provided, there is nothing that the market cannot deliver. If this is taken as a universal proposition, though, the implication is that financial demand stimulus can supply physical resources, of which the most important – the ‘master resource’ – is energy.

The hard facts of the matter are contrary to this proposition. The reality is that no amount of demand stimulus, and no increase in price, can produce anything that does not exist in nature.

It may be true that consumer demand can promote the supply of artefacts. If consumers want a new generation of smartphones, industry will supply them.

So far, so good. But, in a material economy, consumer demand is rooted in prosperity, whilst the ability of industry to respond to demand is dependent on the availability of resources.

The second line of defence for the ‘demand produces supply’ orthodoxy is substitution, meaning that, if a particular raw material is in short supply, market forces will combine with ingenuity to deliver an alternative.

This proposition is now being subjected to the stiffest possible test. An economy built on coal, oil and natural gas is being undermined by scarcity- and depletion-driven rises in fossil fuel costs, and by the worsening environmental consequences of fossil fuel reliance.

To pass this ‘test of substitution’, we would need to be able to transition from fossil fuels to renewables without economic contraction. We have discussed the implausibility of “sustainable growth” on previous occasions, so all that needs to be said here is that full value transition seems extremely unlikely.

In short, we probably can create a sustainable economy built on renewables, but this sustainable economy is going to be smaller – meaning less prosperous – than the economy that has built on fossil fuels.

Past falls in the costs of renewable energy cannot be extrapolated indefinitely, because physics dictates efficiency limits at the level of the individual wind turbine or solar array. Contrary to widespread supposition, technology operates within the parameters of physics, and cannot overcome those restrictions.

If we can’t overcome these limits to efficiency, what remains is a scale issue. If we can’t make wind turbines, solar panels or batteries that have infinite efficiency potential, then we need to build vast numbers of them to enable transition.

And this is where circularity comes into the equation. To build huge numbers of turbines, panels and batteries, we need correspondingly vast quantities of raw material inputs, including steel, concrete, copper, cobalt and lithium. Where these materials exist at all in the requisite amounts, their delivery is a function of the energy required to supply them.

For the foreseeable future, the availability of these resources depends on the legacy energy of fossil fuels. It’s not inconceivable that, at some future point, we may be able – for example – to extract, process and deliver copper, or steel, using renewable energy alone.

The problem with this isn’t feasibility, but efficiency. Renewables may replace fossil fuels in purely quantitative terms, but they can’t replicate the characteristics of oil, natural gas and coal. Oil, in particular, is energy-dense, storable and portable to an extent that electricity cannot match.

A troubled outlook

In past discussions, the SEEDS economic model has been used to provide projections for the scale and composition of the economy of the future. Rather than revisit these forecasting processes, let’s summarise what the key points are.

First, material prosperity will decline, because of the implausibility of replicating the energy value (and, for that matter, the energy flexibility) hitherto provided by fossil fuels.

Second, the real costs of energy-intensive necessities will continue to increase, as a consequence of this same energy dynamic.

Accordingly, the affordability of discretionary (non-essential) consumption will be subjected to relentless compression, as will the affordability of investment in new and replacement productive capacity and infrastructure.

These are the material or ‘real economy’ consequences of a deteriorating energy dynamic.

But there are financial, social and intellectual implications as well. The financial system is wholly predicated on perpetual economic growth. As this precept turns out to be fallacious, the financial system will need to be redesigned on very different assumptions. It’s hard to see how the existing financial system can give way to a new one without extreme trauma.

Intellectually, we should be prepared for the failure of an economic orthodoxy that has been created over more than two centuries of virtually continuous economic growth. Ideas are, to a considerable extent, products of their times and conditions. It’s no surprise that conventional economics has endeavoured to explain the growth that was visible to all participants in the process.

Hitherto, growth hasn’t stopped because of our inability to explain it effectively. Just as economists have developed financial theories about growth, the energy dynamic has carried on delivering growth itself.

In other words, the intellectual challenge has shifted, from explaining the presence of growth to explaining its absence.

Politically, the need to reinterpret the economy will undercut the political platforms of parties whose precepts are based on the old consensus of perpetual expansion driven by financial management.

Economically ‘liberal’ political movements are particularly exposed to this unfolding process. Their central assertion is that we need to accept the deficiencies of the market system – with inequality the most obvious such deficiency – because liberal market economics can be relied upon to deliver growth.

If this claim is invalidated – along with every other thesis founded on perpetual growth – any party which relies upon it faces the invalidation of its central principle.

Absolute monarchy, for instance, failed when the public ceased to believe in the divine right of kings, and when monarchs failed to deliver prosperity. This intellectual-material axis was at the heart of the French Revolution, a product both of new ideas and of hardship.

If economic liberalism is going to be seen as delivering inequality without the compensating benefit of material improvement, then its day has passed.

The task now – of finding an intellectual and political replacement for liberalism – is as challenging as the designing of a post-growth financial system.