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Complexity, energy return on energy invested, and employment

The discussion continues in the US about economic recovery (it was somehow reported this past week at 3.5% for the last quarter). People keep asking typical and often meaningless questions. “Is this growth sustainable?” “But employment is still rising, when will unemployment go down?” To many in the research community that study society from a “whole systems” mentality, the answers to these questions are obvious in the long run even if few short term solutions exist to alleviate any real or perceived economic pain or loss of lifestyle. Oh, and the answers to the two questions are “no”, and “when we (the US) accept lower lifestyles”.

This weekend, Timothy Geithner, the US Treasury Secretary appeared on the popular Sunday talk show Meet the Press. Geithner was asked when employment (unemployment is US is measured at 9.8%) would start to rise, and when the budget deficit and national debt would stop growing. His answer was the mainstream view. This view is essentially that the economic stimulus funds are providing the base investments for growth in the future, and they will “take a while.” Another way of looking at this statement is, that because private businesses spent years, if not the past couple of decades, making the wrong types of investments and/or expecting the wrongly high returns, the government is now making the right kind of investments that will make those same high returns. Oh, and create jobs.

Unfortunately, the research on energy and economics is showing us that the trends are not indicating that these future expectations will come to fruition. I present two areas of research to think about together.

(1) Work on economic production functions by Robert Ayres of INSEAD indicates that investments in increased labor no longer produce economic gains for the US. Work by Ayres and his colleagues (often Ben Warr) on how energy, or rather “energy services” (which they term more precisely “exergy services” or “useful work”) relate to economic growth shows that investments in energy services and capital are practically the only drivers of economic growth at this stage of development in the US. If we consider, as many economic production functions do, that the “factors of production” are of three main categories, (i) capital, (ii) labor, and (iii) energy (or energy services), then Ayres’ work shows that every dollar invested in capital or energy is each responsible for half of economic growth, and investments in labor are responsible for well less than 5% of economic growth.

See: an interview and/or journal paper from Ayres and Warr Interview: http://tv.insead.edu/video/EconomicsPolitics/2/7544 Journal paper: Ayres, RU, Sustainability economics: Where do we stand? Ecological Economics 2008 67(2) 281–310.

(2) Research on the trends in energy return on energy invested (EROI) for fossil fuels undergoing the inevitable decline. This does not necessarily have anything to do with whether or not there are large fossil resources, but can have something to do with describing fossil reserves (those that are economically recoverable). What this declining EROI means is that even though we have continually produced and consumed more energy (worldwide) and have large coal and natural gas resources, they will still not provide for the economic growth of the past.

One example of conceptualizing pionts (1) and (2) above is natural gas. The natural gas (NG) inudstry is now on a public relations campaign to explain the resource base increased by technologies to extract natural gas from shale rocks. So yes, we now have a greatly (2–3X) expanded resource base of NG, but at what EROI? These resources cannot be economically produced at the $2/MMBtu of the year 2000, and need closer to $6/MMBtu for a price. Thus, the EROI of unconventional NG could be 3X less than conventional NG. So the conculsion is, we may have 100 years of domestic NG in the US based upon current consumption, and these resources are valueable, just not as valuable as past resources.

What all this means is that economic growth, as defined since the industrial revolution, cannot happen as fast as the past. The conversion of energy resources, including both renewables (dependent upon current solar income) and fossils (benefitting from hundreds of millions of years of solar income) for productive uses simply requires more energy and resources than in the past. Thus, there is less excess available for other economic sectors, and most economists, businesses, and governments have not accepted this position. There is little incentive for them to do so, except for energy companies themselves since their livelihood is dependent upon making proper judgments of how EROI relates to their monetary return.

Furthermore, investments in energy technologies, capital, and resources that increase labor in the energy sector relative to past investments, inherently go against the trends of the last 100 years. This is not a result of bad public policy, bad tax incentives, overtaxation or even bad business practices. This is a result of increasing complexity of our society such that investments just no longer provide the larger marginal return as they used to, and perhaps they are no longer providing a marginal return at all anymore (think bank bailouts, two wars: Afghanistan and Iraq, health care reform).

We think more energy equals more capabilities, but that equation is incorrect. EROI is a necessary and important factor to understand. When EROI is high, there is a large margin for error and a high degree of discretion when making investment decisions. As EROI decreases, there is less margin for error, and each error can become more influential for a system that has been built upon higher EROI and still expects it. The pay of investment bankers and automaker executives together with health care technologies are results enabled by high EROI that enabled their existence to begin with. They are only causes of budget deficits and debt when we refuse to adjust. This point of adjustment, or lack thereof, is where we reside today.

Posted by Carey King on November 1, 2009 4:33 PM | Permalink