The Thermodynamic Economy

The last twelve months or so of economic chaos has taught those of us in the peak oil community some useful lessons. Perhaps the most valuable of these lessons is extent to which conventional economic ideas have failed to make sense of the way that the twilight of fossil fuels is working out in practice.

Not too long ago, it bears remembering, most people on all sides of the peak oil debate – believers, skeptics, and everyone in between – assumed that the law of supply and demand would necessarily define the world’s response to the end of cheap oil. As existing reserves depleted, nearly everyone agreed, the intersection of decreasing supply and rising demand would drive prices up. Common or garden variety cornucopians insisted that this would lead to more drilling, more secondary extraction, and other measures that would produce more oil and bring the price back down; techno-cornucopians insisted that this would lead to the discovery of new energy resources, which would produce more energy and bring the price back down; green cornucopians insisted that this would finally make renewable energy cost-effective, and at least keep the price from rising further; and pessimists argued that none of these things would happen, and the price of oil would rise steadily on up into the stratosphere.

None of them were right. Instead, as the world crossed the bumpy plateau surrounding its 2005 production peak, oil prices moved up and down in waves of increasing violence, culminating in a drastic price spike driven in part by speculative greed, and followed by an equally drastic crash driven in part by speculative panic. The shockwaves from that spike and crash were not solely responsible for the economic power dive that followed – most of a decade of hopelessly misguided fiscal policy, criminal negligence in the banking and business sectors, and a popular psychology of entitlement extreme even by the standards of past speculative disasters, all had their own parts to play – but even a financial world less shaky than the house of cards that imploded last year would have had a hard time dealing with the body blow inflicted on it by the oil spike and its aftermath.

The rubble from that collapse is still bouncing, even as politicians and pundits insist that the worst is over and a recovery will follow shortly. (This is not exactly comforting; the politicians and pundits of an earlier day said exactly the same thing during the “sucker’s rally” of 1930, when stock markets and other economic indicators regained much of the ground lost in 1929 before plunging catastrophically in the years that followed.) One thing that’s already become clear amid the dust and rubble, though, is that models of the future that assumed a steady upward rise in prices don’t apply to the much more complex reality of spike and crash that is shaping our energy future.

Somewhere in the midwest, perhaps, where a half-completed ethanol plant whose parent company has gone bankrupt is being sold for scrap, and oil leases bought for high prices last June sit unused because the current price of oil won’t justify their development, the dream of a smooth market-driven transition to a different energy system is rolling across a field with the tumbleweeds. Meanwhile the price of oil is continuing its stubborn refusal to obey the laws of supply and demand. Demand has dropped, as consumers and businesses caught in the economic downdraft cut costs, and stockpiles are ample, but the price of oil has doubled since its post-spike low, following a slow, ragged, but unmistakable upward trend.

What makes this all the more fascinating is that oil has shown the same habit of standing economic rules on their heads before. Back in the 1970s, one of the great challenges facing the economics profession was the riddle of stagflation. According to one of the most widely accepted rules of macroeconomics, inflation and deflation – which can be defined precisely as expansion and contraction, respectively, of the money supply – form two ends of a continuum of economic behavior. Rising prices, rising wages, and increased economic activity leading to overproduction are all signs of inflation, while flat or declining prices and wages and diminished economic activity leading to recession are all signs of deflation. In the wake of the Seventies oil shocks, though, the industrial world found itself in the theoretically impossible situation of an inflationary recession: prices were rising, but wages struggled to keep pace, and economic activity declined sharply.

That was stagflation. For more than a decade, economists tried to make sense of the riddle it posed, before finally giving up with a certain amount of relief in the Reagan years, and deciding that it was an anomaly that had gone away and so didn’t matter any more. To many of the economists who tried to make sense of stagflation, it was clear enough that the oil crises had had something to do with it, but this in itself posed its own awkward questions. The economics of commodity prices had been studied exhaustively since the time of Adam Smith, but the behavior of the world economy in the face of rising oil prices violated everything economists thought they knew.

Only a few economists at the time, and even fewer since then, realized that these perplexities pointed to weaknesses in the most basic assumptions of economics itself. E.F. Schumacher was one of these. He pointed out that for a modern industrial society, energy resources are not simply one set of commodities among many others. They are the ur-commodities, the fundamental resources that make economic activity possible at all, and the rules that govern the behavior of other commodities cannot be applied to energy resources in a simplistic fashion. Commented Schumacher in Small is Beautiful:

“I have already alluded to the energy problem in some of the other chapters. It is impossible to get away from it. It is impossible to overemphasize its centrality. [...] As long as there is enough primary energy – at tolerable prices – there is no reason to believe that bottlenecks in any other primary materials cannot be either broken or circumvented. On the other hand, a shortage of primary energy would mean that the demand for most other primary products would be so curtailed that a question of shortage with regard to them would be unlikely to arise” (p. 123).

If Schumacher is right – and events certainly seem to be pointing that way – at least one of the basic flaws of contemporary economic thought comes into sight. The attempt to make sense of energy resources as ordinary commodities misses the crucial point that energy follows laws of its own that are distinct from the rules governing economic activities. Trying to predict the economics of energy without paying attention to the laws governing energy on its own terms – the laws of thermodynamics – yields high-grade nonsense.

Look at the way that rules governing the availability of other resources go haywire when applied to energy. When North America’s deposits of high-grade iron ore were exhausted, for example, the iron industry switched over to progressively lower grades of ore; these contain less iron per ton than the high-grade ores but are much more abundant, and improved technology for extracting the iron makes up the difference. In theory, at least, the supply of iron ore can never run out, since industry can simply keep on retooling to use ever more abundant supplies of ever lower-grade ores, right down to iron salts dissolved in the sea.

Try to do the same thing with energy, by contrast, and two awkward facts emerge. First, the only reason the iron industry can use progressively lower grades of ore is by using increasingly large amounts of energy per ton of iron produced, and the same rule applies across the board; the lower the concentration of the resource in its natural form, the more energy has to be used to extract it and turn it into useful forms. Second, when you try to apply this principle to energy, you very quickly reach the point at which the energy needed to extract and process the resource is greater than the energy you get out the other end. Once this point arrives, the resource is no longer useful in energy terms; you might as well try to support yourself by buying $1 bills for $2 each.

This difficulty can be generalized: where energy is concerned, concentration counts for much more than quantity. That’s a function of the second law of thermodynamics: energy in a whole system always moves from high concentrations to low. Within the system, you can get energy moving against the flow of entropy, but only at the cost of reducing a larger amount or higher concentration of energy to waste heat. That’s how fossil fuels came into existence in the first place; the vast majority of hundreds of millions of years of energy from sunlight falling on prehistoric plants were degraded to waste heat and radiated into outer space, and in the process a very small fraction of that sunlight was concentrated in the form of carbon compounds and buried underground.

The same rule of concentration explains a great many things that current economic ideas miss. Consider the claims made every few years that we can power the world off some relatively low-grade energy source. Latent heat stored in the waters of the world’s oceans, for example, could theoretically provide enough power for the world’s economy to keep it running for some preposterously long period of time, and any number of inventions have tried to tap that energy. They’ve all failed, because it takes more energy to concentrate that heat to a useful temperature than you get back from the process. The same is true a fortiriori of “zero point energy,” the energy potential that according to current physics exists in the fabric of spacetime itself. It doesn’t matter in the least that there’s an infinite amount of it, or something close to that; it’s at the lowest possible level of concentration, and thus utterly useless as a power source for human society.

The same limits apply, if less strictly, to many of today’s renewable energy sources. Solar energy, for example, is very abundant, but it’s also very diffuse. As with any other energy resource, you can concentrate some of it, but only by letting a larger quantity of it turn into waste heat. It’s quite common to hear the claim that because solar energy’s so abundant, our society can easily power itself by the sun, but this shows a failure to grasp thermodynamic reality. Today’s industrial societies require very highly concentrated energy sources; our transportation networks, our power grids, and most of the other ways we use energy, all work by degrading very high concentrations of energy all at once into waste heat, and without those highly concentrated resources, those things won’t work at all.

Now of course there are plenty of productive things that can be done with more diffuse energy sources. Once again, solar energy provides a good example. Passive solar heating for buildings is a mature and highly successful technology; so is solar hot water heating; so are a good many other specialized uses, such as using solar ovens for cooking, water purification, and the like. All these can contribute mightily to the satisfaction of human needs and wants, but they presuppose very different social and economic arrangements than the centralized energy economy of power plants, refineries, pipelines and power grids we have today. As concentrated energy from fossil fuels becomes scarce, in other words, and more diffuse energy from the sun and other renewable sources has to take up the slack, many of the ground rules shaping today’s economic decisions will no longer apply.

What this implies, in turn, is that economics does not exist in a vacuum. The ground rules just mentioned took shape, after all, in an age where economic processes were dominated – one might even say “distorted” – by our species’ temporary access to extravagant supplies of cheap and highly concentrated fossil fuel energy. The new ground rules of economics that will take shape in the twilight of the age of cheap energy, in turn, will be shaped by the fact that energy is once again scarce, costly, and diffuse. More generally, it’s necessary once again to pay attention to the myriad ways that human economic systems are rooted in the wider processes of the natural world – a theme that will be central to next week’s post.

Survival Isn't Cost-Effective

I trust my readers won’t be unduly distressed by an extended safari through the tangled jungles of the “dismal science” of economics. As suggested in several recent Archdruid Report posts, economic factors have played a massive role in putting the industrial world in its current predicament, and an even more substantial role in blocking any constructive attempt to get out of the corner into which we’ve painted ourselves. There’s an all too real sense in which, if modern industrial civilization perishes, it will be because the steps necessary for its survival weren’t cost-effective enough.

Mind you, this can be interpreted in at least two different ways, and both of them are relevant to the crisis of the industrial world. Like any other science, economics is a set of hypothetical models that reflect, with more or less exactness, the observed behavior of the world. Too often the models get confused with the reality, and understanding suffers.

In a different context, that of the physics of vacuum tubes, Philip Partner commented in his classic textbook Electronics (1950): “The theory speaks of ions, atoms, and electrons, and of collisions between them; but these are figments of the mind, props for its understanding. [...] The electron, like the atom, is a concept; it is part of a mental shorthand which we have invented to summarize our knowledge of Nature. So when we say, for example, that an electron collides with an atom, we should bear in mind that we have never seen it happen. The use of the present indicative does not turn hypothesis into fact” (p. 569). Unfortunately this level of clarity is hard to achieve and harder to maintain.

This has to be kept in mind when trying to make sense of the economic dimension of industrial civilization’s decline and fall, because both sides of the equation – the models and the reality – throw up challenges in the way of constructive action, and so do economic policies that are based on the models, and thus function at a second remove from the reality. It’s true, and will be a central theme of future posts, that current economic theory has lost touch with reality in critical ways, and a revision of some of the basic ideas of modern economics is essential if we’re to make sense of our predicament and do anything constructive in response to it. It’s equally true that government policies based on today’s misguided economic notions have become massive liabilities to societies struggling to deal with today’s crisis, and even this late in the game, changes in these policies might still do a great deal of good. Still, it’s also true that economic factors in the real world, independent of theory, impose hard limits on what can be done.

The classic example has to be the plethora of projects for “lifeboat communities” floated in recent years. The basic idea seems plausible enough at first glance: to preserve lives and knowledge through the decline and fall of the industrial age, establish a network of self-sufficient communities in isolated rural areas, equipped with the tools and technology they will need to maintain a tolerable standard of living in difficult times. The trouble comes, as it usually does, when it’s time to tot up the bill. The average lifeboat community project I’ve seen would cost well over $10 million to establish – many would cost a great deal more – and I have yet to see such a project that provides any means for its inhabitants to cover those costs and pay their bills in the years before industrial civilization goes away.

The unstated assumption seems to be that as soon as the intrepid residents of such a community move into their solar-heated cohousing units, start up the wind turbines and the methane generators, and get to work harvesting tree crops from the permacultured landscaping all around, industrial civilization will disappear in a puff of smoke and take its taxes, debts, and miscellaneous expenses with it. Pleasant though the prospect might seem, I am sorry to say that this isn’t going to happen. The residents of any lifeboat community founded today will not only have to come up somehow with the very substantial sums needed to buy the land, build the cohousing units, wind turbines and so on, and plant all that permaculture landscaping; they will also have to earn a living during the long transitional process that leads from the world we inhabit today to the conditions that will pertain at the bottom of the curve of decline. Some awareness of these difficulties may go a long way to explain why, of the great number of lifeboat communities that have been proposed over the last decade or two, the number that have actually been built can be counted on the fingers of one foot.

Economic forces constrain the future in more global ways as well. Not many people seem to have noticed, for instance, that the grim scenario traced out in the seminal 1973 study The Limits to Growth – still the most plausible map of the future ahead of us, and thus inevitably the most bitterly vilified – is driven by simple economics. As resources deplete, that study pointed out, the cost of keeping resources flowing into to the economy will increase in real terms, as more labor and capital have to be invested to extract a given amount of each resource; as pollution levels rise, in turn, the costs of mitigating their impacts on public health, agricultural productivity, and other core economic factors go up in the same way, and for the same reasons. Those costs have to be paid out of current economic output, leaving less and less for other uses, until economic output itself begins to fall and the industrial world begins its terminal decline.

Now it’s easy to insist, if you ignore the economic dimension, that a society facing this sort of crisis can save itself by launching a massive program to build nuclear reactors, solar thermal power plants, algal biodiesel, or what have you, and of course this sort of claim has seen endless rehashing over the last couple of decades. The problem is that massive programs of this sort pile additional demands on an already faltering economy. Any such program has to be paid for, after all, and by this I don’t mean that money has to be found for it; in today’s mostly hallucinatory economic climate, conjuring money out of thin air is easy enough. No, it has to be paid out of current economic output, which is much less flexible, and already has to cover the rising costs of resource depletion and pollution. This is the trap hidden in the limits to growth; once those limits begin to bite, the spare economic capacity that would be needed to build one’s way out of trouble no longer exists.

Thus there are limits hardwired into our situation by the inflexible realities that surround us, and we have already strayed far enough over those limits that the payback will inevitably be harsh. At the same time, other forces pushing us in the same direction are a product of economic misunderstandings, and in the way these misunderstandings are reflected in public policy. Those could conceivably be changed in time to matter.

Resource depletion and pollution, the driving forces behind the Limits to Growth scenario, are particularly vexed issues in today’s economic thought. As we’ve seen, both of these factors impose costs, potentially drastic ones, on the economy. Under current economic arrangements, however, those costs are not charged to the people who benefit from the activities in question. The owner of an oil well gets the economic benefits of pumping oil out of the ground, but does not have to pay for the impact today’s extraction will have on tomorrow’s economy. (For many years, in fact, government policies in most of the world’s industrial nations have actually rewarded oil well owners for accelerating the depletion of this nonrenewable resource and imposing massive costs on the future.) In the same way, the owner of a smokestack that dumps pollution into the atmosphere gets the economic benefits of whatever activity produces the pollution, but does not have to pay for the costs incurred as a result of the pollution. This asymmetry has at least two results. First and most obviously, neither the oil well owner nor the smokestack owner has any incentive to decrease the negative impacts of his or her activities. Still, the second and in some ways more important result is that the long-term economic burdens of depletion and pollution are not included in measures of the relative economic costs and benefits of the well or the smokestack.

The result is a massive distortion in our understanding of the realities that shape our lives. It’s generally not considered a viable business plan – outside of the financial industry, that is – to make large profits in the short term by running up debts so large the business will have to declare bankruptcy in the not too distant future. Yet this is exactly what an economic system that ignores the cumulative costs of resource depletion and pollution mitigation is doing, and on an even larger scale. The future costs of extracting resources from depleted reserves and mitigating the impacts of a polluted environment have the same effect as the future costs of debt service on excessive borrowing; they buy temporary prosperity in the near future at the cost of impoverishment or collapse further down the road.

Garret Hardin’s famous essay “The Tragedy of the Commons” addressed this issue some years back. Hardin showed that in a situation where the benefits from exploiting a resource went to individuals, but the costs were spread throughout the community, individuals intent on maximizing their own individual benefit would overexploit the resource and suffer drastic losses in the longer run. His logic was impeccable, and there are plenty of real-world examples of resource exhaustion driven by this very process, but it has been pointed out by his critics with equal relevance that resources held in common have in fact been managed sustainably in countless cases around the world and throughout history. The question that has to be asked is where the difference comes in.

This is where the divide pointed up earlier in this essay – the gap between economic realities and the models our society uses to understand them and predict their effects – comes into play. Hardin was quite correct that when individuals got the benefits of resource exploitation without paying their fair share of the costs to the community, exhaustion of the resource follows. Those societies that have managed resources in common successfully, in turn, found ways to make those who gained the benefits of resource exploitation pay a commensurate share of the costs. The collective understanding of economics in these societies, in other words, and the social policies that shaped economic behavior, took the tragedy of the commons into account and adjusted the customs and laws governing economic exchanges accordingly.

As we make the transition from what I’ve called the abundance economies of the first half of the industrial age to the scarcity industrialism of the near and middle future, it’s entirely possible that such adjustments could be put into place in our own societies. The accumulated burdens of past mistakes weigh heavily enough on the future that changes of this sort won’t stave off a great deal of trouble and suffering, but it’s entirely possible that a shift to saner policies backed by more realistic economic ideas could cushion the descent into the deindustrial age, and make it easier to allocate resources to projects that will actually do some good, instead of pursuing policies which – like nearly all the economic policies currently in place in the industrial world – will simply make matters worse.

On The Road

I'd hoped to be able to write a couple of posts in advance to keep The Archdruid Report going over the next two weeks, during most of which I'll be on the road and out of reach of the internet. Unfortunately the time hasn't worked out, so the next regular post will be on Wednesday, June 17. In the meantime, I'm pleased to report that The Ecotechnic Future, the sequel to The Long Descent, is on track for a September release and can be preordered now. Thank you all for contributing to the conversation that has made both these books possible -- and, with a little luck. might just enable us to cushion the descent into the deindustrial age.