Perhaps no statement by economists causes physical scientists more aggravation than the claim that the economic importance of energy can be measured by its dollar share in total GDP. Here I explore some of the arguments for both sides of that claim.
Econbrowser readers will be very familiar with Stuart Staniford, whose thoughtful observations have added greatly to the quality of the comments sections on many previous posts. He’s now writing regularly for the Oil Drum, and made some very interesting points there last week:
consisting entirely of bodies in a state of rest or uniform motion would not be much of an economy. Instead, almost
all economically significant actions involve some forces being applied to some bodies….From an economic perspective, if you want action faster (more acceleration) you will need more force, and
if you want more stuff moved (greater mass), you will need proportionately more force also. So there
should already be some sense that the total amount of forces being thrown around in the economy must
be related somehow to the total amount of economic activity.
Although I agree with his physics, I don’t agree that the level of economic activity has any necessary connection to the amount of force being thrown around. Consider two of the areas in which we’ve seen the greatest economic growth over the last twenty years, computing and medical care. Today you can perform something like 50 billion floating point operations per second for 5 watts of electricity. Stuart could do a much better job than I could of coming up with a graph of FLOPS per watt as a function of time, but I have no doubt that it would exhibit a spectacular rising trend. The reason is that the nature of technical progress here has been to make the physical dimensions of what is being moved around smaller and smaller– today’s computers are better precisely because they’re trying to move electrons over shorter and shorter distances.
Or consider medical advances. Antibiotics, immunization, pharmaceuticals, and improved surgical methods have produced profound economic advances. We stand on the verge of almost inconceivable progress over the next century as we put into practical use our ability to read the genetic code of ourselves and our diseases. Here again what we actually need physically to induce are tiny events at the molecular level. Economic progress consists entirely of getting smarter at knowing exactly how to do that.
Nor are computers and health care all that exceptional. The graph at the right plots the ratio of the number of barrels of oil that the U.S. uses each year to real GDP (measured in year 2000 dollars). Year after year, economic activity has consistently grown at a faster rate than our physical consumption of oil.
None of this is to deny Stuart’s observation that if we had no energy, there would be no economic activity. But it would be equally accurate to claim that, if we had no labor, there would be no economic activity. That doesn’t mean we should subscribe to an energy theory of value any more than we should believe in a labor theory of value, or, for that matter, an aquatic theory of value, since, after all, you and I would perform most unsatisfactorily if we were to be completely denied access to H20. Energy, labor, water, and a great many other things are valuable, even indispensable, for economic activity.
But the question is not, how well would we function if we used no energy, but rather, how well would we function if we used a little less energy? If you had to reduce your gasoline consumption a little, what could you do? Maybe you would figure out a way to combine errands, make more use of public transportation, share rides, or use a more fuel-efficient vehicle. You’d rather not do those things, and you won’t do them voluntarily, unless the price of gasoline rises. If it does rise and you do cut your energy use, how would we measure how much worse off you are as a result of the changes you were forced to make? One approach would be to take the amount by which you’ve reduced your gasoline consumption (call it Q) and multiply it by the price (P). The reason that’s a logical measure is that you could have considered giving up any of a number of other things rather than reducing your gasoline consumption– fewer movies, fewer new clothes, or whatever. The dollar value of clothes, etc. you would have had to give up to keep your gasoline consumption constant is given by P x Q. You decided those things were worth more to you than the extra gasoline (else you would have given them up, not the gas). Thus the economic value to you of what you’ve lost by being forced to reduce your gas consumption is less than P x Q. This reasoning suggests that the economic importance to the overall economy of losing a given quantity of oil could be measured by the dollar share of that lost oil in total GDP.
Back to Stuart’s analysis:
I have a college level Macroeconomics textbook by my side. It devotes about two out of 519 pages to consideration of energy, wherein it says nonsense like: “Because energy constitutes a small proportion of the nation’s total expenditure on inputs, most statistical studies suggest that higher energy prices did not contribute much to the slowdown [in the 1970s].”
I made a related statement about standard macroeconomic models here, which may have been part of what encouraged Stuart to give up on my blog and start writing one of his own.
Despite the disagreements noted above, I expect that Stuart and I would agree on many of the substantive issues. For example, as I argued in the post just referenced, my own view is that energy prices did contribute to the economic slowdowns in the 1970′s, not because of the lower energy use per se (whose effect, I agree with the nonsensical macroeconomic textbook, could be measured from the dollar value of the lost energy), but rather because these oil shocks caused adjustments in a number of other inputs besides energy. What we’re all watching for in the present situation is whether similar adjustments again occur over the next several months.
Another key issue in which both Stuart and I share an interest is what will happen when global petroleum production begins to decline. As ever larger curtailments in energy use are sought, the economic cost of further reductions will become greater, essentially for the reasons that Stuart is giving. This means that energy’s dollar share will start to rise as oil production begins to decline. As Stuart has correctly pointed out in a different post, if depletion rates turn out to be very rapid, we could move very quickly into that regime in which energy has a large dollar share, meaning that further reductions in its supply have tremendous economic consequences. Precisely the same economic reasoning that might lead you to conclude that energy by itself should not matter that much in 2005 could lead you to conclude that energy by itself might matter a great deal in 2015.
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