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Page added on May 11, 2017

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Breaking New Ground in Economic Theory

Consumption

Steve Keen defines a production function based on energy

Professor Steve Keen may be the first mainstream economist to address a fatal flaw in economic theory: omitting or minimizing the role of energy. Keen has developed a production formula incorporating energy, not as one factor of production along with capital and labor, but as the indispensable flow activating both.

“Labor without energy is a corpse” says Keen; “Capital without energy is a sculpture.”

Keen was one of twenty or so economists who made a credible prediction of the 2008-9 crisis, which government economists in the US and abroad declared “unpredictable” – after it blindsided them. His work draws on contemporary economic theory and generates real-world predictions. He’s the sort of economist who financial commentators, investors and even government economists listen to; folks who haven’t heard of Daly’s steady state economy, Odum’s energy flow analysis of the ecosystem-economy, or Hall’s EROI “cheese slicer” model.

Keen’s model implies that economic production is measurable in energy units, as Odum and others argued. Wealth is “nothing but the food, conveniences and pleasures of life,” as the earliest economists recognized. But it results from useful work, which can be measured in kilocalories. (To us weight watchers, just “calories.”) Here is his fundamental equation (the only one here, I promise):

Y(E) = (K.EK.xK.eK)α . (L.EL.xL.eL)1-α

(If that seemed hard to read, try coding it in html.) It’s worthwhile to look at what goes into this equation, the product of a Capital term and a Labor term. Each of these terms is itself a product of energy flow and two small modifiers. To define the terms,

Y is useful work or GDP, a function of energy supply, in kilocalories
K is capital, as the number of machines employed
L is labor, as the number of workers involved
E is a flow of energy to the economy, to workers or to machines, in kilocalories
α is capital’s proportional contribution to production (labor’s contribution is 1-α)
x is Exergy, the proportion of E which is actually usable, always great than zero and less than 1. Per the second law of thermodynamics, some energy is always lost.
e is the efficiency of the process: the proportion which actually goes into production after the costs of maintaining the machine or the worker; always greater than zero and less than 1. Logically this factor should include whole life cycle costs, though I’m not sure if Keen intends this.

To test his model against real data, Keen correlated its results with historical statistics of US GDP, and then compared correlations of GDP with the key terms individually. Over 40-odd years of data, his function correlated 0.79 with US GDP. The correlations with employment (Labor) alone and energy consumption (E) alone were much lower, at 0.60 and 0.59 respectively.

His model might have correlated better if applied to a closed economic system, such as the entire world, or the US prior to 1970, if good data were available. Most of the useful work that supports Americans today is performed in the Far East or in the engines of container ships, and the energy inputs are considerable.

Introducing his test data, Keen remarked that government statistics showing minimal unemployment were “just nonsense”. He presented a measure of employment instead.

“They ask what Trump is complaining about- here’s what he’s complaining about..” (This was back in November.)

A decline of a few percent seems small, but two million fewer Americans in their working years have jobs than before the 2008-9 crisis.

Presenting a chart of industrial energy consumption 1960-present, Keen remarked on the on the long decline since the 1979 peak, his latest values showing consumption comparable to 1967-8. Partly the result of increased efficiency, he said, but also “..becoming intractable because we are moving from highly efficient oil and coal to much less efficient wind and solar.” (Efficiency as energy output per unit of energy input.)

I don’t think I’m overstating to say that Keen’s model marks a breakthrough in mainstream economics, though Keen describes it as merely

“..the beginnings of a decent equation to explain the role of energy in production.”..demonstrating that wealth is “..fundamentally created by the exploitation of free energy, as the Physiocrats argued two centuries ago.”

For those who discount any economic reasoning not expressed in calculus, Keen’s work opens an access to the wisdom of the Physiocrats. Maybe that of Daly, Odum and Hall as well.

Nearly all I’ve said above is taken from Keen’s lecture on You tube, which I highly recommend. There’s a lot more there, including deep historical background and comparisons with contemporary economic theories. If you haven’t listened to a real science lecture since college, it may wake up some brain cells.

Postscript
Having called Keen a “mainstream economist”, I now notice in his blog that he contrasts himself with mainstream economists and complains of a strong institutional bias toward the Neoclassical school. He’s asking for support via Patreon, partly to continue his work on energy-based economic modeling (I signed up.) Still, he’s a lot more mainstream than the environmental scientists I mentioned above.

Eclectications blog



12 Comments on "Breaking New Ground in Economic Theory"

  1. CIA-MOLE on Thu, 11th May 2017 8:29 am 

    So we have an economist who is nostalgic. It’s a good thing he’s also honest in his worshiping of Physiocrats. These people focused on the metabolic processes of life.

    But today if I buy a car, it would cost the same amount of money I use to feed myself for years.

    Adding the contribution of energy is cool but not all that groundbreaking.

  2. Dredd on Thu, 11th May 2017 8:39 am 

    Very keen (The Queens of Stalingrad – 9).

  3. rockman on Thu, 11th May 2017 9:00 am 

    CIA – “Adding the contribution of energy is cool but not all that groundbreaking.” I agree but that’s easy for someone that spent the last 4 decades in the energy business. Obvious the effect is concentrated in us but we’re just a portion of the global economy. But a major portion. But so is agriculture. Ag activity that has required more fossil fuel input as commercial ag has become dominant over the last half century. Add the dependency of most US/developed country economic activity on electricity… power that’s sourced primarially from fossil fuels.

    With just those components considered it seems rather rediculous to think that “main stream” economists haven’t focused on energy/fossil fuel input in their analysis. I assume the article is correct in that assertion of neglect. I wouldn’t know since I’ve never paid much attention to such studies.

  4. Hubert on Thu, 11th May 2017 9:30 am 

    It is amazing just how little Economist know anything about energy. These idiot economists thinks economy starts in an empty vacuum.

  5. joe on Thu, 11th May 2017 9:42 am 

    Seems to make sense, now how many kilocalories untill we know spaceX is a pointless waste of time.

  6. Davy on Thu, 11th May 2017 10:21 am 

    It is pretty clear most economic theory is not up to the 21st century of converging predicaments. It works well enough for in-house modern civilization issues. It works well to tell itself what it wants to hear and that is primarily continued progress in techno optimism. Affluence is a given when the proper polices are implemented per economics. These policies vary but I have seen no economic policy that is based on decline and decay. All economic theory I have seen is growth based with the exception of Herman Daly with his steady state theories.

    Economics theory begin to break down in a finite world of limits when minimums are approached and diminishing returns reduces effectiveness of economic activity. We can further mix in planetary system decline and the civilizational decline. Many of these decline issues cannot be modeled by traditional means. The idea we can substitute and innovate through limits and discount or dismiss abstract planetary and civilizational conditions means a significant dimension to the human experience is ignored. This was fine once upon a time when we were ignorant of today’s predicaments. These problems were present but not yet known. They were distant and not a material factor then.

    We are now in population overshoot and economist say more population is good for growth. We are in the midst of energy issues and economist say we can substitute. Economist believe in sustainable development that will solve many social issues and lessen our environmental destructiveness. Economist continue to be all over the place in regards to the new normal of repression and monetarization. Yet, the one variable in common is all of them have their own solution if their policy is implemented.

    This does not mean many or not worried. It is apparent with economics and the sciences that at some point denial is chosen. Climate scientist deny science when it comes to solutions because there are no solutions to existential catch 22 predicaments. Most scientist offer solutions to most of our problems but these solutions are mostly optimistic projections of what might be with the right technology. The documentation of the problems is OK despite the corruption and manipulation. Dig hard enough and you can find the truth but solutions are not and represent a lie. Economist point to grave dangers ahead with debt and extremes of unbalanced economic activity but most remain in denial that the global system is now so forced and compressed at thresholds of decline we may not survive another economic disruption. Science has not written off civilization yet.

    This is a social condition of a modern people unable to contemplate its end. Society does not tolerate narratives opposed to the status quo of growth through individual rights found in liberal democracy. Market based capitalism is supreme. Everything is priced today and having money is power. Money is our collective blood and the basis of all worship. It is not so much a conscious policy but more an unconscious condition. Our system is based on optimism and growth. A little fear is tolerated as useful for motivation and risk reward. What is not heard is collapse and decline except on the fringe. Collapse is more for entertainment and fiction. Collapse does not fit into what powers the status quo. If the status quo leadership did make collapse discussion routine as is done with financial guidance of the central banks, what then? It is likely the status quo would not survive so we can see the predicament. Science and economics that we rely on to guide us in risk management are not allowed to address the possibility of collapse and extinction. We then have a situation of more of the same and the same is more of what got us here and here is a cliff.

  7. penury on Thu, 11th May 2017 10:52 am 

    A very good analysis Davy, Economics has morphed into a “religion” among the different philosophies. Are you Kensyian? or Austrian? And as is true with all fanatics you cannot argue with them because their views are based upon “faith’ and to question faith is to destroy the whole system.

  8. onlooker on Thu, 11th May 2017 11:13 am 

    Current Economic dogma is pressing up against limits to growth invalidating their precious theories. And by refusing to see holistically the problems it has fast become an obsolete tool for humanity

  9. Apneaman on Thu, 11th May 2017 11:42 am 

    ECONOMICS AS RELIGION: from Samuelson to Chicago and Beyond, Robert
    H. Nelson
    [pp 49‐59]

    “Indeed, when Economics is put under a close value lens, or studied with the aim of identifying its
    implicit religious message, its claims to value neutrality appear as mostly the rhetorical flourishes of an
    era that suffered from many illusions in this regard. There is a powerful value system, a secular religion
    in essence, lying at the heart of Economics. Its progressive message has reached two generations of
    American undergraduates, preaching the scientific management of American society, now to be
    supervised at the highest levels by the members of the American economics profession, who will bring
    about sustained economic growth and development.”

    http://dieoff.org/_Economics/Sameulson.pdf

  10. Apneaman on Thu, 11th May 2017 12:04 pm 

    Second Law of Thermodynamics May Explain Economic Evolution
    November 2, 2009

    “(PhysOrg.com) — Terms such as the “invisible hand,” laissez-faire policy, and free-market principles suggest that economic growth and decline in capitalist societies seem to be somehow self-regulated. Now, scientists Arto Annila of the University of Helsinki and Stanley Salthe of Binghampton University in New York show that economic activity can be regarded as an evolutionary process governed by the second law of thermodynamics. Their perspective may provide insight into some fundamental economic questions, such as the causes of economic growth and diversification, as well as why it’s so difficult to predict economic growth and decline.
    As Annila and Salthe explain in their study published in Entropy, the second law of thermodynamics was originally formulated to describe the flow of heat from hot to cold areas. However, when formulated as an equation of motion, the second law can be used to describe many other processes in energetic terms, such as natural selection for the fittest species, organization of cellular metabolism, or an ecosystem’s food web. In these systems, free energy is consumed; that is, energy is dispersed in a way to promote the maximal increase of entropy, which is the essence of the second law.
    While economic activities are traditionally viewed as being motivated by profit, Annila and Salthe argue that the ultimate motivation of economic activities is not to maximize profit or productivity, but rather to disperse energy”.

    https://phys.org/news/2009-11-law-thermodynamics-economic-evolution.html#jCp

    “…but rather to disperse energy”

    Oh ya! That right there is the humans meaning for existence – to disperse energy.

    Little thermodynamic puppets on the universal stage – playing their tiny part. No gods, no afterlife, no meaning, just little energy dispersers. Why? Who knows children, the universe (multiverse?) works in mysterious ways.

    Now go out there and do your part – consume consume consume – and drop any bags full of guilt and regret you may be carrying. Consuming the goodies is why you exist after all; it’s why the universe made you. Dopamine, dopamine dopamine until death do us part.

  11. dave thompson on Thu, 11th May 2017 12:42 pm 

    “…but rather to disperse energy” Energy in = Economy out.

  12. Plantagenet on Thu, 11th May 2017 1:19 pm 

    Prof. Keen’s Youtube channel:

    https://www.youtube.com/user/ProfSteveKeen

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