Energy and the Wealth of Nations; An Introduction to Biophysical Economics

Energy and the

Wealth of Nations

Charles A.S. Hall

Kent Klitgaard

An Introduction to Biophysical Economics

Second Edition

Energy and the Wealth of Nations

Charles A.S. Hall

Kent Klitgaard

Energy and the

Wealth of Nations

An Introduction to Biophysical Economics

Second Edition

Charles A.S. Hall

College of Environmental Science & Forestry

State University of New York

Syracuse, New York, USA

Kent Klitgaard

Wells College

Aurora, New York, USA

ISBN 978-3-319-66217-6 ISBN 978-3-319-66219-0 (eBook)

https://doi.org/10.1007/978-3-319-66219-0

Library of Congress Control Number: 2018935116

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To Myrna, my wonderful companion on this and other journeys.

Charles A.S. Hall

To my children, Justin and Juliana Klitgaard Ellis, who have grown from wonderful

children into fine adults, and to Deborah York who continues to make me a better

person.

Kent A. Klitgaard

Preface

There are four books on our shelf that have

the words, more or less, “wealth of nations”

in their titles. They are Adam Smith’s 1776

pioneering work, An Inquiry into the

Nature and Causes of the Wealth of Nations,

and three of recent vintage, David Landes’

The Wealth and Poverty of Nations, David

Warsh’s Knowledge and the Wealth of

Nations, and Eric Beinhocker’s The Origin

of Wealth. Warsh’s book is rather support￾ive of current approaches to economics

while Beinhocker’s is critical, but all of

these titles attempt to explain, in various

ways, the origin of wealth and propose

how it might be increased. Curiously, none

have the word “energy” or “oil” in their

glossary (one trivial exception), and none

even have the words “natural resources.”

Adam Smith might be excused given that,

in 1776, there was essentially no science

developed about what energy was or how

it affected other things. In an age when

some 80 million barrels of oil are used

daily on a global basis, however, and when

any time the price of oil goes up a reces￾sion follows, how can someone write a

book about economics without mention￾ing energy? How can economists ignore

what might be the most important issue in

economics? In a 1982 letter to Science

magazine, Nobel Prize economist Wassily

Leontief asked, “How long will researchers

working in adjoining fields ... abstain from

expressing serious concern about the

splendid isolation within which academic

economics now finds itself?” We think

Leontief ’s question points to the heart of

the matter. Economics, as a discipline, lives

in a contrived world of its own, one con￾nected only tangentially to what occurs in

real economic systems. This book is a

response to Leontief ’s question and builds

a completely different, and we think much

more defensible, approach to economics.

For the past 130 years or so, economics has

been treated as a social science in which

economies are modeled as a circular flow

of income between producers and con￾sumers where the most important ques￾tions pertain to consumer choice. In this

“perpetual motion” of interactions

between firms that produce and house￾holds that consume, little or no accounting

is given of the necessity for the flow of

energy and materials from the environ￾ment and back again. In the standard eco￾nomic model, energy and matter are

ignored or, at best, completely subsumed

under the term “land,” or more recently

“capital,” without any explicit treatment

other than, occasionally, their price. In

reality economics is about stuff, and the

supplying of services, all of which are very

much of the biophysical world, the world

best understood from the perspective of

natural, not social, sciences. But, within

the discipline of economics, economic

activity is seemingly exempt from the need

for energy and matter to make economies

happen, as well as the second law of ther￾modynamics.

Instead we hear of “substitutes” and “tech￾nological innovation,” as if there were

indefinite substitutes for matter, energy,

and the environment. As we enter the sec￾ond half of the age of oil, and as energy

supplies and the social, political, and envi￾ronmental impacts of energy production

and consumption become increasingly the

major issues on the world stage, this

exemption appears illusory at best. All

forms of economic production and

exchange involve the transformation of

materials, which in turn requires energy.

When students are exposed to this simple

truth, they ask why are economics and

energy still studied and taught separately?

Indeed, why is economics construed and

taught only as a social science, since in

reality economies are as much, and per￾haps even principally, about the transfor￾mation and movement of all manner of

biophysical stuff in a world governed by

physical laws?

VII

Part of the answer lies in the recent era of

cheap and seemingly limitless fossil energy

which has allowed a large proportion of

humans to basically ignore the biophysical

world. Without significant energy or other

resource constraints, economists have

believed the rate-determining step in any

economic transaction to be the choice of

insatiable humans attempting to get maxi￾mum psychological satisfaction from the

money at their disposal, and markets

seemed to have an infinite capacity to

serve these needs and wants. Indeed the

abundance of cheap energy has allowed

essentially any economic theory to “work”

and economic growth to be a way of life.

For the last century, all we had to do was to

pump more and more oil out of the ground.

However, as we enter a new era of “the end

of cheap oil,” in the words of geologists and

peak oil theorists Colin Campbell and Jean

Laherrere, energy has become a game

changer for economics and anyone trying

to balance a budget.

In brief, this book:

5 Provides a fresh perspective on eco￾nomics for those wondering “what’s

next” after the crash of 2008 and the

near cessation of economic growth for

much of the Western world since then

5 Summarizes the most important infor￾mation needed to understand energy

and our potential energy futures

In summary, this is an economics text like

no other, and it introduces ideas that are

extremely powerful and are likely to trans￾form how you look at economics and your

own life.

Charles Hall

Polson, MT, USA

Kent Klitgaard

Aurora, NY, USA

July 2017

Preface

Acknowledgments

We thank the Santa Barbara Family

Foundation, Roger C. Baker Jr., the UK

Department for International Develop￾ment, the Endeavor Foundation, and sev￾eral anonymous donors for financial

support; Steven Bartell, Garvin Boyle, and

Jim Gray for excellent editing of words and

ideas; Michelle Arnold for assistance in

getting the first edition together; Rebecca

Chambers, Ana Diaz, Michael Sciotti and

Heather Hiltbrand for their able assistance

with the data analysis, editing, and graph￾ics for the first edition, and to Tyler Lewis,

Sarah Halstead, and Bellina Mushala for

assistance with the second edition; and our

students over the years for helping us think

about these issues. We thank the late, fan￾tastic Howard Odum, who taught us about

systems thinking and the importance of

energy in everything, and John Hardesty

and Norris Clement, who introduced Kent

to the limits to economic growth. We

thank our colleagues economists Lisi Krall

and John Gowdy for providing valuable

advice and critique for this and other proj￾ects. Their continued collaboration makes

our work stronger. We also thank David

Packer, Executive Editor at Springer, for

believing in us and Myrna Hall and

Deborah York for the loving support and

infinite patience. We owe a special debt of

appreciation to Tina Evans, who provided

excellent and valuable suggestions for

revising the first edition into what we

believe is a much stronger and clearer

second edition.

IX

Contents

I Economies and Economics

1 How We Do Economics Today ................................................................................................... 5

2 How We Got to Where We Are Today: A Brief History of Economic

Thought and Its Paradoxes ........................................................................................................ 23

3 Problems with How We Do Economics Today ................................................................... 67

4 Biophysical Economics: The Material Basis ........................................................................ 81

5 Biophysical Economics: The Economics Perspective .................................................... 101

II Energy and Wealth: An Historical Perspective

6 The Evolution of Humans and Their Economies ............................................................. 123

7 Energy, Wealth, and the American Dream ......................................................................... 151

8 The Petroleum Revolution and the First Half of the Age of Oil ............................... 183

III Energy, Economics, and the Structure of Society

9 The Petroleum Revolution II: Concentrated Power

and Concentrated Industries .................................................................................................... 211

10 Twentieth Century: Growth and the Hydrocarbon Economy ................................... 227

11 Globalization, Development, and Energy .......................................................................... 259

12 Are There Limits to Growth? Examining the Evidence ................................................. 277

13 The Petroleum Revolution III: What About Technology? ............................................ 289

IV Energy and Economics: The Scientific Basics

14 What Is Energy and How Is It Related to Wealth Production? .................................. 299

15 The Basic Science Needed to Understand the Relation

of Energy to  Economics ............................................................................................................... 323

16 The Required Quantitative Skills ............................................................................................ 361

17 Is Economics a Science? Social or Biophysical? ............................................................... 377

X

V The Science Behind How Real Economies Really Work

18 Energy Return on  Investment .................................................................................................. 387

19 Peak Oil, EROI, Investments, and Our Financial Future ............................................... 405

20 The Role of Models for Good and Evil .................................................................................. 425

21 Applying a Biophysical Economics Approach to Developing Countries............. 439

VI Understanding How Real-World Economies Work

22 Peak Oil, Secular Stagnation, and the Quest for Sustainability .............................. 459

23 Fossil Fuels, Planetary Boundaries, and the Earth System ........................................ 475

24 Is Living the Good Life Possible in a Lower EROI Future? ........................................... 487

Supplementary Information

Index ...................................................................................................................................................... 507

Contents

XI

Authors’ Biographies

Charles Hall

is a systems ecologist who received his PhD under Howard

T.  Odum at the University of North Carolina at Chapel Hill.

Charles Hall is the author or editor of 14 books and 300 arti￾cles. He is best known for his development of the concept of

EROI, or energy return on investment, which is an examina￾tion of how organisms, including humans, invest energy into

obtaining additional energy to improve biotic or social fit￾ness. He has applied these approaches to fish migrations,

carbon balance, tropical land use change, and the extraction

of petroleum and other fuels in both natural and human￾dominated ecosystems. Presently he is developing a new

field, biophysical economics, as a supplement or alternative

to conventional neoclassical economics, while applying sys￾tems and EROI thinking to a broad series of resource and eco￾nomic issues.

Kent Klitgaard

is professor of economics and the past Patti McGill Peterson

professor of social sciences at Wells College in Aurora,

New York, where he has taught since 1991. Kent received his

bachelor’s degree at San Diego State University and his mas￾ter’s degree and PhD at the University of New Hampshire. At

Wells, he teaches a diverse array of courses including the His￾tory of Economic Thought, Political Economy, Ecological Eco￾nomics, The Economics of Energy, Technology and the Labor

Process, and Microeconomic Theory and is a cofounder of the

Environmental Studies Program. Kent is active in the Interna￾tional Society for Ecological Economics and is a founding

member of the International Society for BioPhysical Econom￾ics. Recently, his interests have turned toward the degrowth

movement, and he has published multiple papers on the sub￾ject for Research and Degrowth. He has two children and is

interested in the outdoors in general: from hiking to beach

walking to the occasional round of golf (despite the high

energy use of golf courses). Kent is a Californian who still surfs

the frigid waters of New England when he gets a chance.

1 I

Economies and

Economics

Economies exist independently of how we study them.

Consequently, there may be significant differences between how

an actual economy operates and how we study it. In this section,

we will assess how we perceived and taught economics at

various times. We begin with the dominance perspective of

today, neoclassical economics, in chapter one. In the second

chapter, we examine various perspectives from the history of

economic analysis from the 18th to the 20th centuries, focusing

on the diverse theoretical viewpoints from the past, most of

which have little to do with the dominant view of the present.

7 Chapter 3 examines the present approach more closely from

the perspective of how well that view is related to actual econo￾mies. It frequently finds the present view severely wanting,

particularly in that it pays little attention to, and indeed is often

inconsistent with, the biological and physical world upon which

it is necessarily based. 7 Chapter 4 introduces a new, different,

way in which we can examine economies, one that is in fact

based on a proper biophysical underpinning. This approach is

called biophysical economics. We emphasize the critical impor￾tance of energy here. 7 Chapter 5 adds a social perspective that

is part of, and consistent with, the essential biophysical frame￾work of this innovative approach.

In general, the entire discipline of economics has paid only a very

little attention to energy even though energy was, and remains,

the basis of economic activity and growth. Rather economics has

treated energy as it treats any other material resource: as a

commodity, useful but ultimately substitutable by other com￾modities. Historically, economists focused their efforts upon

capital and labor, and, occasionally, land as the driving economic

forces. However, energy issues lay not far beneath the surface of

economic reality and many economic concepts. Before the era of

classical political economy, English manufacturers had learned to

substitute coal for increasingly scarce charcoal to provide heat for

their processes. In 1784, James Watt patented a steam engine that could provide rotary

motion. The coal-driven industrial revolution was soon to follow. Economies had a new

characteristic: growth. Economists now think of growth as a normal characteristic of

economies, but this is only a relatively recent phenomenon, and it is highly linked to

increasing energy supplies, something that was not characteristic before about 1800.

This book is written by an ecologist and an economist, and part of our objective is to

assess where insights and principles from these two disciplines can be combined to

understand economies and nature, and their interactions, better. While the two disci￾plines may appear very different, we believe instead that the phenomena they study

are very similar in many ways. From a biological perspective, the economies of cities,

regions, and nations can be viewed as ecosystems, with their own structures and

functions, their own flows of materials and of energy, and with diversity and stability.

Human-dominated systems can exhibit many of the characteristics of natural systems.

At the same time, ecology is often referred to as “the economy of nature.” There are

similarities and differences between organisms in nature and people in modern econo￾mies: lions eat gazelles and gazelles eat grasses, trout subsist on insects, and plants

exploit nutrients in soils and space in which to intercept sunlight. Individuals and

groups find themselves in a relentless struggle to increase their energy gains and

decrease energy costs, for their ability to pass on its genes is possible only if it has

managed to acquire a large net energy balance. This is also true for humans, but

humans are different in that we consciously order the labor process and produce for

surplus, rather than for immediate use alone. Producing for surplus dates to the

Neolithic transition from hunting and gathering to settled agriculture.

When first encountering the words “biophysical economics,” most readers probably

asked, “what do those words mean?” The answer is deceptively simple: The word

“biophysical” refers to the material world, that which is usually, but not completely,

covered by courses in physics, chemistry, geology, biology, hydrology, meteorology,

and so on. This can be compared with a “social” or “anthropocentric” (i.e., human￾centered) perspective that characterizes modern economics. In this second perspec￾tive, which is dominant in our society, humans believe that they can make any world,

or set of decisions, or economic systems that they wish – if they can just get the

policies right and enough time has passed for new technologies to come on line. The

subsequent world becomes our new reality and truth.

But we must ask: How do the powerful, governing physical laws, which we are all

prepared to accept in physics, chemistry, and biology classes, operate outside of the

scientist’s laboratory and the “natural” world? Scientists often think of these laws as

imposing constraints on a system. Do these constraints really disappear when human

ingenuity is applied to economics and markets? Most economics textbooks would lead

you to this conclusion, as growth is just a matter of human actions, technologies,

policies, and a healthy dose of ambition. Western culture and its leading commenta￾tors (with a few exceptions such as Joseph Tainter and Jared Diamond) do tend to

elevate personal and social aspects of a problem, specifically, human actors and their

ideas, above any biophysical considerations. Thus, we learn about history as the action

of great leaders; wars, if not always battles, are usually won or lost due to the biophysi￾cal resources that generals can bring to bear. Napoleon once quipped that “God fights

on the side with the best artillery.” There is little debate that the South had the better

generals in the Civil War, but the North had the industrial might. The North won

because of biophysical, not leadership, issues.

Most readers would not argue with the idea that we live in a world that is completely

beholden to the basic laws and principles of science. These basic laws include New￾ton’s laws of motion, the laws of thermodynamics, the law of the conservation of

matter, the best first principle, the principles of evolution, and the fact that natural

ecosystems tend to make soil and clean water while human-modulated systems tend

to destroy both. Do economic systems operate outside of these laws? Did the seem￾ingly unconstrained technological and economic expansion of the twentieth century

show that these laws were irrelevant or at least insignificant when applied to econom￾ics and the satisfaction of human needs and wants?

There is no more important question as we attempt to move beyond the recent

financial trauma of the “Great Recession” and the enduring “secular stagnation.” Unfor￾tunately, the biophysical laws, particularly as applied to energy, are not understood or

appreciated by most people, including most economists. Ironically, our focus on

exploiting and investing energy in the economic process has divorced many people

from the very biophysical realities that are necessary to sustain them. This includes our

ways of building dwellings, living in cites, importing food, being transported and

entertained, and so on while isolating our energy using activities in areas generally

isolated from people’s daily lives. In this book, we examine these issues through an

integrated view of economics that emphasizes scientific principles and a more fre￾quent use of the scientific method. Together these chapters provide the beginnings of

a powerful new way to think about economics.

3 I

Contents

Chapter 1 How We Do Economics Today – 5

Chapter 2 How We Got to Where We Are Today: A Brief History

of Economic Thought and Its Paradoxes – 23

Chapter 3 Problems with How We Do Economics Today – 67

Chapter 4 Biophysical Economics: The Material Basis – 81

Chapter 5 Biophysical Economic: The Economic Perspective – 101