34 Biophysical Economics

The field of ecological economics is extremely heterogeneous but can be separated, in my opinion, into two factions: those who wish to measure ecosystems in monetary units and those who wish to measure the human economy in biophysical units. (Blair Fix)

Yan Abstract

Global civilization is experiencing social and economic turmoil. Human are experiencing dete- rioration of environment and uncontrollable declines in GDP. Traditional economic theory has been continuously advancing yet seems unable to predict these crises or provide adequate public policies to address them. A biophysical version of economic theory uses mass and energy flows as well as environmental constraints to describe the delivery of goods and services. Ongoing development in biophysical economic theory may provide some new guidance. In this review paper, Authors analyze the progression of historical economic arguments, explore their assump- tions and their development and compare them to the currently developing biophysical econom- ics framework which, instead of focusing on investment, debt, and growth, focuses on sustainable energy and mass flows to deliver goods and services to civilization

Yan Memo

Table 3. Comparison between biophysical economics and mainstream economics.

Content	Neo-Classical	Biophysical
Wealth root	Land, Labor, Capital	Energy
Distribution	Market	Resource Constraints
Hypothesis	Rational people	Base on Nature
Determinants	Labor and Capital	Energy
Gov. role	Macro Control	Env.protection

Yan (2019) (pdf)

Fix

This book tested four implicit assumptions made by neoclassical growth theory:

Economic output can become decoupled from energy inputs.
Economic distribution is unrelated to growth.
Large institutions are not important for growth.
Labor force structure is not important for growth.

In all cases, the empirical evidence directly contradicted these assumptions. For those who think that a scientific theory should be based on empirically grounded facts, this critique alone provides compelling reasons to abandon neoclassical growth theory.

To conclude, the shortcomings of neoclassical growth theory can be summarized as follows:

It does not explain the phenomenon for which it is designed to explain. The majority of growth is attributed to the ‘Solow-residual’, which is an inter- nalized error function. Neoclassical economists model the residual with an exponential function of time. However, if resorting to a function of time, Oc- cam’s razor would suggest that we discard the remainder of the production function in favor of a pure function of time.
There are fundamental problems associated with the measurement of the the- ory’s basic variables (output and capital input). The accepted method is to

measure capital and output quantities by way of monetary value. However, such an approach requires making inherently subjective decisions, since the underlying unit (price) is not well-defined. Moreover, it appears that the cur- rent approach to measuring capital and output may be circularly dependent on neoclassical theory. Therefore, such metrics are inappropriate for testing neoclassic theory.

Its implicit assumptions are directly contradicted by empirical evidence. Rather than being ‘innocuously’ untrue, the implicit assumptions made by neoclassical theory are ‘insidiously’ untrue. The theory excludes from its scope some of the most fundamental aspects of growth. Thus neoclassical growth theory maintains simplicity by courting irrelevance.
The remaining empirical support for the theory is tautological. The strong empirical results on which neoclassical growth theory purportedly rests nei- ther elucidate the underlying technical form of the economy nor provide sup- port for the marginal productivity theory of distribution. Instead, they are the result of a tautological relation between the production function form and an algebraic transformation of the national accounts identity. Where, then, does this leave neoclassical growth theory? It seems fair to conclude that it is an elegant mathematical construct that has little to do with the real world.

A Biophysical Approach

Such a theory must begin by asking a very simple question, but one that is not often asked in economic theory: why do we have growth at all? Indeed, growth is such an ephemeral phenomenon in the history of humanity that its very existence should be surprising. In my opinion, satisfying theories about the origins of growth do not come from economics, but from thermodynamics and the study of complex systems. In order to understand why growth exists, I propose that we need only two hypotheses:

All complex, non-equilibrium systems must be sustained by flows of energy and/or matter. Increases in these flows allow the system to expand.
An industrial economy is a non-equilibrium system that is energetically sus- tained primarily by exploitation of the finite stock of fossil fuels. Growth, then, is possible whenever a new energy source is made available. Prior to industrialization, technological constraints prevented humans from exploiting fossil fuel energy. However, once sufficient technology existed, a feedback-loop set in. Previously harvested resources and energy were transformed into technology that was powered by fossil fuels and which generated enough surplus to not only power the economy but to exploit further fuels. Continuous iteration of this loop led to exponential growth.

Biophysical growth, as I have defined it in this book, is the increase in the rate at which resources (specifically energy) flow through the economy. Thus, in Bardi and Lavacchi’s model, biophysical growth is represented by the rate of resource extraction ( Ṙ). A robust feature of this model is that it produces bell-shaped resource extraction curves through time.

Even with the imposition of external, biophysical constraints, there is little reason to think that complex social dynamics will cease to be of importance in the future. Thus, an understanding of the future will require models, but also in-depth empirical study of the past.

A Biophysical Approach

Given the inadequacy of neoclassical theory, what is the best alternative? As should be obvious by now, I think that a biophysical approach to growth theory provides the most suitable way forward. Such a theory must begin by asking a very simple question, but one that is not often asked in economic theory: why do we have growth at all? Indeed, growth is such an ephemeral phenomenon in the history of humanity that its very existence should be surprising. In my opinion, satisfying theories about the origins of growth do not come from economics, but from thermodynamics and the study of complex systems. In order to understand why growth exists, I propose that we need only two hypotheses:

All complex, non-equilibrium systems must be sustained by flows of energy and/or matter. Increases in these flows allow the system to expand.
An industrial economy is a non-equilibrium system that is energetically sus- tained primarily by exploitation of the finite stock of fossil fuels.

Growth, then, is possible whenever a new energy source is made available. Prior to industrialization, technological constraints prevented humans from exploiting fossil fuel energy. However, once sufficient technology existed, a feedback-loop set in. Previously harvested resources and energy were transformed into technology that was powered by fossil fuels and which generated enough surplus to not only power the economy but to exploit further fuels. Continuous iteration of this loop led to exponential growth.

What is the simplest way to model this feedback-loop? Bardi and Lavacchi (2009) have shown that the famous Lotka-Volterra equations (which are usually used to model predator-prey dynamics) can be adapted to model the resource ex- ploitation process:

\[ Ṙ = −k_1 T R\]

\[Ṫ = k_2 T R − k_3 T\]

Here \(R\) represents a resource stock and \(T\) represents a stock of technological in- frastructure. Equation 1 states that the rate at which the resource is harvested ( \(Ṙ\) ) depends upon the size of the technological stock, the size of the resource stock, and the efficiency of resource extraction (\(k_1\) ). This equation indicates that a greater technological stock can accelerate resource exploitation, but as the size of the resource stock dwindles (as R decreases), the pace of resource exploitation will slow. Equation 2 states that harvested resources are transformed into technology. The rate of this transformation (\(Ṫ\) ) is dictated by the rate of resource harvest (T R) and the efficiency of the transformation process (\(k_2\) ). Additionally, technology (and its instruments) is subject to entropic decay (\(−k_3 T\) ) at a rate determined by \(k_3\) . Biophysical growth, as I have defined it in this book, is the increase in the rate at which resources (specifically energy) flow through the economy. Thus, in Bardi and Lavacchi’s model, biophysical growth is represented by the rate of resource extraction ( \(Ṙ\)). A robust feature of this model is that it produces bell-shaped resource extraction curves through time. Thus, the essential insights of this model are:

growth can be modelled in terms of a feedback-loop between technology and natural resource extraction; and
the ultimate growth limit is set by the size of the finite stock of resources.

This model gives some analytic rigor to the peak and decline scenario envisioned at the outset of the book. But while it indicates that a future energy consumption curve might be bell-shaped, it does not indicate how a future energy decline will affect society. It is also important to distinguish between external and internal con- straints to growth. External (resource) constraints can describe the long-run behavior of the economy, but internal (social) constraints dominate the short-run. Historical crises have almost all been due to internal, social dynamics (think of the Great De- pression). Even with the imposition of external, biophysical constraints, there is little reason to think that complex social dynamics will cease to be of importance in the future. Thus, an understanding of the future will require models, but also in-depth empirical study of the past.

What is needed is a biophysical research agenda – one that seeks to systematically understand the relation between energy consumption and all aspects of human society. Energy scholars such as Ayres and Warr (2009), Giampietro et al. (2012), Hall and Klitgaard (2012) and Smil (2010) have made significant contributions on this front, but much more work is needed.

Stylized Biophysical Facts

As I stated at the outset of the book, a good starting point for a new theory is to investigate the assumptions made by existing theory. If the results of this book tell us nothing else, it is that a good starting place for a biophysical growth theory is to begin with what neoclassical theory ignores.

Neoclassical growth theory ignores

the role of energy, yet the expansion of energy consumption is the single most im- portant aspect of growth.
distribution, yet distribution is fundamentally connected to growth.
large institutions, yet such institutions play a central role in growth.
changes in labor structure, yet changes in this structure are essential to growth.

A theory is always the product of the phenomena it seeks to explain. What does neoclassical growth theory seek to explain? Nearly 60 years ago, Nicholas Kaldor (1957) outlined six statements that came to be known as the ‘Kaldor facts’ of eco- nomic growth. In many ways, the goal of neoclassical growth theory has been to explain these facts. Kaldor’s facts can be paraphrased as follows:

Output per worker grows at a roughly constant rate that does not de- crease over time.
Capital per worker increases over time.
The capital/output ratio is roughly constant.
The rate of return to capital is roughly constant.
The share of capital and labor in net income are roughly constant.
Labor productivity growth rates vary considerably between societies.

Notice that 5 out of 6 of these facts are concerned with either something that re- mains ‘constant’ (facts 1, 3, 4, 5) and/or something that ‘grows over time’ (facts 1, 2). The logical offspring of these facts is a theory in which growth is constant and inevitable (i.e. neoclassical growth theory). Notice also the focus on capital. Neo- classical growth theory places capital at the center of its explanation of growth, but never bothers to explain where capital comes from.

This neglect is likely the result of the neoclassical duality of capital. Note that when one applies compound interest to financial capital, the financial stock will grow expo- nentially. Neoclassical theory takes the logic of financial capital and applies it to the physical capital stock. Yet such a stock cannot be self-perpetuating – the laws of thermodynamics forbid it. Neoclassical theory fails to see that physical capital (i.e. a technological stock) is primarily a means for converting energy into useful work. Without an energy flow, physical capital cannot fulfil its purpose (think of a tractor without fuel).

By focusing on constant and inevitable growth driven by the accumulation of capital, neoclassical theory set itself on the wrong course from the very beginning. The focus of a growth theory should be on energy. Energy is the driving force that sustains all biophysical systems.

Seven Stylized Biophysical Facts

Trends accompanying increases in energy use per capita:

Large institutions (corporations and governments) increase their employment share.
Agricultural employment decreases.
Service employment increases.

Trends accompanying increases in the energy use per capita growth rate:

The value of production increases relative to the price of energy.
The share of profit in national income increases.
Debt claims decrease relative to the value of production.
Downward income redistribution is more likely to occur.

A good starting point for a biophysical growth theory is to attempt to explain these seven stylized biophysical facts in a way that is both internally coherent and consilient with accepted scientific knowledge.

Energy is the “universal currency”.

Fix (2015) Biophysical Growth Theory (pdf)

** Hall and 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 supportive 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.”

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?

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.

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?

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,” 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.

Hall and Klitgaard (2018) Energy and the Wealth of Nations (pdf)

Ayres Conclusion

The first conclusion from the above analysis is that growth in exergy consumption generally, and electric power consumption in particular, have had an enormous impact on past economic growth. The mechanism responsible has recently been dubbed the rebound effect’ which conveys the notion that increasing efficiency tends to result in lower costs, which trigger increasing demand that (often) results in greater – rather than less – exergy consumption. The second conclusion from our analysis is that thermodynamic efficiency improvements in the production of primary work can account for most of the so- calledSolow residual’, namely that portion of economic growth attributable to `technical progress.’ Secondary work (end-use efficiency improvements) in transportation and some uses of electric power e.g. for lighting) may account for a considerable part of the remainder. We conjecture that the unexplained part of the Solow residual (since 1980) may be mostly attributable to the impact of information technology. The third important conclusion is that, technical progress in the past notwithstanding, there is still an enormous potential for future reductions in exergy consumption, especially in the residential and commercial heating area. A fourth and final conclusion of this paper is that the locus of technical progress has moved from energy (exergy) conversion efficiency to end-use efficiency or service output per unit of work (SOPUW). Purely thermodynamic efficiency improvements were largely exhausted by the 1960s. This does not rule out the possibility of further thermodynamic improvements in the future. However most gains since then have arisen from other factors. Although we have not attempted a detailed accounting of the latter category of improvements, it is very plausible that reduced material consumption per unit of service output has been a major driver of these gains, and that information technology will make increasingly important contributions in the future. A subtler but related, and arguably more important, question is whether the rebound effect is still the primary driver of economic growth and to what extent growth can be expected if the consumption of fossil fuels – the major source of primary exergy in the modern world – can be curtailed in order to stabilize the climate and minimize other kinds of environmental damage.

Ayres (2003) Energy,Power and Work in the US Economy (pdf)