Stochastic Trend

Some interesting observations on social structure in China and Europe and Elinor Ostrom's Nobel Prize Lecture.

So you know where this paper is going, here is the introduction as it currently stands:

Introduction

Is energy an important driver of economic growth and development and if so what factors affect the strength of the relationship between energy and growth? Toman and Jemelkova (2003) argue that most of the literature on energy and economic development discusses how development affects energy use rather than vice versa. The principal models used to explain the growth process (e.g. Aghion and Howitt, 2009) do not include energy as a factor that could constrain or enable economic growth. Economists do pay significant attention to the impact of oil and other energy prices on economic activity in the short-run and there was extensive discussion of the role of oil prices in the "productivity slowdown" that followed the oil price shocks in 1973-74 and 1980-81. Resource economists have developed models that incorporate the role of resources including energy in the growth process. But these ideas remain isolated in the resource economics field. Much of the relevant literature is outside the mainstream in what has come to be known as ecological economics.

The first section of the paper reviews basic physical principles and economic concepts that define the role of energy in economic production and growth. The premise is that gaining an understanding of the role of energy in economic growth cannot be achieved without first understanding the role of energy in production. The principal finding is that criticism of the mainstream theory of economic growth on the basis of the implications of thermodynamics for economic production and growth is legitimate. A theory of economic production and growth must take the essential role of energy into account. On the other hand, theories that try to explain everything on the basis of energy, while ignoring the roles of information, knowledge, and institutions are similarly misguided.

However, institutions also affect how these roles play out and, therefore, the mainstream theory of economic growth, which focuses on these considerations, is reviewed next. The limitations of neoclassical theory’s consideration of energy and other resource issues have been the subject of strong criticism grounded in the biophysical theory of the role of energy. We discuss these criticisms and alternative ecological economics views on energy and growth in the following section. These criticisms focus primarily on limits to substitution and technological change. I present for the first time a theory that rigorously embeds energy use in a mainstream economic growth model. This shows that when energy is scarce it will strongly constrain economic growth, but when energy becomes more abundant energy is much less of a limiting factor and the neoclassical model explains economic growth fairly well.

In the period since 1973 significant reductions in energy intensity have been achieved in many developed and some developing countries. In some countries, energy intensity has declined over a much longer period (Gales et al., 2007). I use the production function concept to examine the factors that could reduce or strengthen the linkage between energy use and economic activity over time. These key factors are:

– substitution between energy and other inputs within an existing technology,
– technological change,
– shifts in the composition of the energy input, and
– shifts in the composition of economic output.

Each of these themes has a subsection dedicated to its discussion. Following this, I review the empirical evidence on the causal link between energy and growth. To be useful, such studies must not be grounded in a single theory, potential mechanism, or school of thought. Therefore, the studies reviewed here are reduced form time series models that do not specify structural linkages between energy and output. As correlation and regression analysis does not imply causality from one variable to another, most of these studies employ the econometric notions of Granger causality and cointegration to test the presence of and direction of causality between the variables.

The final section of the paper presents conclusions and points to implications for energy and environmental policy.

References
Aghion, P. and P. Howitt (2009) The Economics of Growth, MIT Press, Cambridge MA.
Gales, B., A. Kander, P. Malanima, and M. Rubio (2007) North versus South: Energy transition and energy intensity in Europe over 200 years, European Review of Economic History 11: 219-253.
Toman, M. A. and B. Jemelkova (2003). “Energy and economic development: an assessment of the state of knowledge.” Energy Journal 24(4): 93-112.

I remembered Mick Common mentioning this book and I saw that it was referred to by http://stochastictrend.blogspot.com/2009/08/allen-british-industrial-revolution-in.html">Robert Allen. I found that ANU's library had a copy but it was nowhere on the shelves and I put in a missing book search request. It couldn't be found. So I was surprised to get an e-mail while I was in Adelaide telling me to come pick it up from the library! You can see from the cover above that this book was published in 1973. Disappointingly, the copy I'm reading has a boring grey hardback cover.

The central idea of the book is similar to that of Ester Böserup - innovation and economic development are responses to the scarcity caused by increased population. This idea explains a lot, but I think that Wilkinson takes it too far. In his opinion economic development never increases welfare in the long-run. In his view all the innovations of modern industrial society are merely (often inferior) substitutes for goods that were lost in the industrialization process that was necessary to cope with increased population. If this were really true then why don't countries with low population densities relative to resources in today's world (New Zealand?) adopt a medieval way of life?

I think the idea does explain a lot about pre-industrial societies and the beginning of the industrial revolution. As Allen also documents, coal was an inferior fuel to wood, at least until innovations for using coal effectively came into play. Both authors agree that the scarcity of wood in England drove the increased adoption of coal for many uses.

Another important idea in the book is that many pre-industrial societies had various institutions to control population including taboos on sex at certain times or between certain classes of people, contraception methods, abortion, and infanticide. Some pre-industrial societies, therefore, managed to stay well within ecological bounds. Without facing the pressure of meeting subsistence needs there was little reason to innovate. When Christian missionaries arrived in many such places they tried to eliminate these institutions with a resultant take off of population growth.

The main methods in Christian Europe were delayed marriage in periods of reduced prosperity due to high population and (not mentioned by Wilkinson) monastic and priestly orders. These were less effective at maintaining the population within the carrying capacity for a comfortable lifestyle. England already reached carrying capacity in the 14th century. The Black Death then wiped out a large proportion of the population. Only in the 17th century was carrying capacity again approached. The eventual response was the agricultural and industrial revolutions. Would industrialization have started earlier if the Black Death plague hadn't happened?

One of my colleagues, Sambit Bhattacharya, has an article out on natural resources and corruption. Their conclusion is:

"Resource-rich countries are often cursed by corruption and governance problems. This column shows that the natural resource curse burdens non-democracies, but countries with better democratic institutions are not corrupted by such endowments. For governments accountable to their citizens, resources can be a blessing."

Democratic countries are mostly less corrupt and they argue that if democracy is established before resources are discovered then the resources do not promote corruption. Maybe that explains Indonesia where democracy has been established only recently and corruption is high.

I've been looking at the relationship between resource endowment and carbon emissions with a couple of other colleagues recently (more on this if and when we get a working paper out). Definitely the economies with large resource endowments tend to have higher and apparently faster growing carbon emissions. Partly this is due to mining being a very energy intensive industry but probably also due to these countries (e.g. Australia) not regulating or taxing resource use as stringently as countries with small endowments. Is this due to a difference in perceptions of resource security? Or is this due to the resource lobby actively preventing regulation? And if it is the latter is that a form of corruption? It's not included in indices of corruption but it is definitely "rent-seeking".

Here is a draft of my review to be published in Ecological Economics of Prosperity without Growth:


Prosperity without Growth: Economics for a Finite Planet

By Tim Jackson, Earthscan, London, 2009.

Reviewed by David I. Stern

Usually, I find myself disagreeing with advocates of zero economic growth (defined as non-increasing GDP). First, a large part of the world’s population remains poor by any objective standard and second, I think they have the wrong end of the stick. If the reason that we are concerned about growth is its impacts on the environment we should control resource use and then let the economy determine the optimal level of output within the constraints that are set. And controlling resource use, hard as that has proven to be, is still likely to be both politically and practically an easier goal than somehow directly controlling growth. So, I was a little surprised to find myself agreeing with quite a lot of what Tim Jackson writes in Prosperity without Growth. Jackson is Economics Commissioner for the UK’s Sustainable Development Commission and Professor of Sustainable Development at the University of Surrey.

Jackson draws parallels between the global financial crisis and the looming ecological crisis. Anglophone (and some continental European) economies artificially boosted consumption in recent years by promoting very lax credit standards and low interest rates. Borrowing from the future to fund today’s fun. This irresponsibility, which met its denouement in the credit crunch is matched by the irresponsibility of borrowing resources and assimilative capacity from the future to fund today’s economic growth. In the case of mineral resources and even fossil fuels we could argue that we are developing the technology with which to “pay back” our borrowings but no such argument can be made on biodiversity and habitat loss and the build up of carbon in the atmosphere.

Jackson then reviews the lack of impact of income on national happiness after subsistence needs are met and asks whether growth is still necessary in order to maintain prosperity. Would a zero growth economy have rising unemployment as technology continues to advance (assuming technology does still advance and as implicitly assumed by Jackson in the main text that GDP is produced by a Cobb-Douglas function of capital and labor)? Such an economy will require less and less labor if wages rise. Either wages have to be constant or average hours worked would have to decline. Such an economy could be a utopia or a dystopia depending on which of these dominates and how the reduction in work hours is distributed. Following the lead of Peter Victor (2008), Jackson advocates some regulation of working hours. But, if we restrict the use of natural resources and resources are not good substitutes for capital and labor, as Jackson himself proposes in the Appendix, labor-augmenting technical change (on its own) in fact becomes rather futile (Jackson assumes technological change augments all inputs equally). This is because adding more effective labor to fixed resources has limited results when labor isn’t a substitute for resources. There is then no increasing labor productivity problem to solve. And if resources are good substitutes for labor then there really isn’t a problem with growth per se. Controlling the use of resources would have limited impact on growth and limiting growth would be the wrong focus.

Jackson also highlights the “myth of decoupling”. Though there have been improvements in the energy and resource intensity of GDP in many economies over time, in very few economies have these gains been more rapid than economic growth. Therefore, global energy and resource use and carbon emissions have continued to rise. Decoupling or environmental Kuznets curve effects are the exception rather than the rule. The rebound effect means that a focus on improving environmental efficiency will reduce impacts by less than one would naively think. Neither is there salvation in the service sector – most services are still fairly energy intensive in both their production and consumption. But, in order to achieve the ambitious goal of stabilizing atmospheric concentrations of carbon dioxide at 450ppm by 2050, global carbon intensity will have to decline by an unprecedented 7% per annum from now till then if population and income grow as expected under business as usual scenarios. Put another way, carbon intensity will have to improve 21 fold in the next 40 years. Jackson believes that that is more than can reasonably be achieved and, therefore, growth must come to an end.

Unfortunately, Jackson misinterprets the estimates of the cost of climate policy generated by computable general equilibrium (CGE) models, writing: “The Stern Review famously argued that “the annual costs of achieving stabilization… are around 1 per cent of global GDP.” After mentioning some other estimates he writes: “Though all these numbers look rather small, there’s something very confusing about cost estimates like these: they are already about the same order of magnitude as the difference between a growing economy and a non-growing economy. So if these costs really represent an annual hit of around 2-3 per cent of GDP they would essentially already wipe out growth” (83-84). It is hard to believe, but CGE models actually state that climate policies would cause GDP to be lower by 2-3% in 2050 than it would otherwise be rather than grow at 2-3% less each year. An economy that grows at 2% less each year has GDP that is 54% lower after 40 years.

This is actually a central point. Prosperity without Growth argues that decarbonization with growth is too hard. Therefore, growth must halt. But leading mainstream economics policy models state that the costs of climate policy are very low and, therefore, there is no incompatibility between growth and decarbonization. I suspect that the truth is somewhere in the middle. Moderate cuts in emissions (20-30%) are likely to be very cheap. But once efficiency and fuel-switching options are exhausted the switch to solar and nuclear energy may have much higher costs. Reviewing the parameter values in CGE models, I think that they may overestimate the ease with which consumers can substitute away from fossil-fuel intensive goods and services.
On the other hand, as Jackson points out, growth as we know it looks set to continue the trend to higher resource prices that we saw leading up to the record oil prices of mid-2008. Can business as usual growth continue anyway in the face of rising resource scarcity?

The book is an easy read and despite my disagreements on some points has plenty of substance. There is also much more in this book – discussions of consumerism and governance for example – than I can cover in this review. Jackson rounds off the book with a set of specific policy proposals and a vision of the transition to sustainability. The policy proposals (presumably directed at developed economies such as the United Kingdom) are:

Establishing the limits: caps on emissions and resource use and targets for reduction; green tax reform; support for ecological transition in developing economies.

I wholeheartedly agree with all these suggestions.

Fixing the economic model: Here Jackson proposes a mix of changes to the practice of economics – green accounting and developing an “ecological macro-economics” – and practical measures like investment in green infrastructure and new financial regulation such as the Tobin tax and increasing bank reserve ratios.

Of course, I think ecological macro-economics should be encouraged but I am less enthusiastic about green accounting – more data on the state of the environment is of course valuable but aggregating that data into the national accounts using monetary valuation can give us false indications about sustainability (see Stern, 1997). 100% reserve banking appears to be favored by some ecological economists but is a complete non-starter as it literally means that banks cannot make loans. These are then money warehouses rather than financial intermediaries. Outlawing short-selling and imposing the Tobin tax are likely to make financial systems less efficient. But we should look at limiting the size of financial institutions and regulating credit more tightly again.

Changing the social logic: Policies on working time, inequality, “measuring capabilities”, strengthening social capital, and dismantling consumerism.

If reduced growth in a resource-constrained economy does lead to reduced labor demand we may need new policies to address increasing inequality. Not all societies and individuals will prefer the approaches advocated by Jackson. Limiting employment hours along French lines would drive the more entrepreneurial into self-employment perhaps increasing inequality further. On the other hand, competition for status probably really does result in “positional externalities”. But incentives are more appropriate than blunt one-size fits all regulation.

In conclusion, I think that we should not treat this book as a necessarily correct diagnosis of our predicament and prescription for our future. But it does provide a very thought-provoking research and policy agenda for ecological economists who understand the size of the challenges we face.

References
Stern D. I. (1997) The capital theory approach to sustainability: a critical appraisal, Journal of Economic Issues 31, 145-173.

Victor P. (2008) Managing without Growth: Slower by Design, not Disaster, Edward Elgar, Cheltenham.

I have been reading Collapse, Jared Diamond's account of the collapses of several past civilizations - Easter Island, the Maya, the Anasazi, and the Greenland Norse settlement prominent among them - and discussions of environmental stresses and sustainability issues in modern societies. Included is some original research of his with a coauthor on the factors affecting success or failure in the Pacific Islands. He also discusses a few cultures which adapted and moved back from the brink, including Tokugawa Japan, the New Guinea Highlands, Tikopia and medieval Iceland. In the case of Tikopia success involved the wiping out of two of the clans by the one surviving clans while in Iceland severe desertification occurred in the uplands before things stabilized. So success is relative.

My preconception was that he would be overly deterministic about the role of environmental degradation in these stories. But that isn't the case. In fact, for an economist things seem a bit too open ended. He tries to explain these examples by a five factor theory but I can summarize in fewer points, I think.

Societies tend to overshoot their carrying capacity when either they experience long periods of favorable climate (e.g. Greenland) or move into new areas where they misperceive the carrying capacity even in the short-run (e.g. Iceland). In the latter case environmental degradation results causing a fall in carrying capacity. In the former a change in climate for the worse is the cause in fall in carrying capacity. What happens next depends on the fragility of the environment and the rigidity of institutions. A more fragile environment (e.g. Easter Island vs sustainable example) or more rigid institutions increases the likelihood of collapse. For example, the Greenlanders seem to have eaten no fish for inexplicable reasons and otherwise seem to have tried to maintain European style agriculture rather than adopt ideas from the native Americans (they did hunt seals but not all types). Rulers need to show their people that they can provide for them to legitimate their rule as well as compete with rival rulers. It might make more sense to try to maintain the current system at continuing environmental cost until it finally collapses rather than admit that it has failed. At the same time temples (Maya) or statues (Easter Island) tend to get bigger and bigger.

We can certainly see the same symptoms in our world today. Rulers seek legitimacy by maintaining economic growth. There is a fear of accepting even small reductions in GDP in order to protect the climate. And conservative attitudes in institutions prevail. The Greenlanders didn't want to be like the Inuit, while conservative Americans don't want to be like the French or Swedish today. As institutional economists long-ago noted technology changes faster than institutions do.