Economists for Future: Why is understanding the global energy system essential for understanding economic trends?

Carey W. King: Just like biological organisms, the economy must consume energy resources to grow, organize, and maintain itself.  Thus, living systems, including our economy, simply find ways to take advantage of these energy conversions.

The energy system is the part of the economy (people, infrastructure) that obtains primary energy resources from the environment (e.g., things humans do not create: coal, sunlight), converts them into final energy carriers (electricity), and distributes those carriers to machines that do work. A core economic understanding starts with the environment-economy interface in terms of extracting free energy.  

Consider pre-industrial England (from 1300s to 1700s) as a biomass-based (thus solar) economy with energy costs equal to 40-60% of GDP. Pre-industrial energy includes food for people and fodder for animals, both of whom act as prime movers that work the land to do what? Produce food and fodder, or energy! Thus, before fossil-fuelled machinery, almost everyone was part of the energy system.  

Industrialized growth is largely characterized by a decline in food and energy costs relative to GDP, and today (globally) this metric is less than 10% (with a similar low percentage of people working in food and energy in industrialized countries). However, since the year 2000 this “energy + food cost” metric has not continued its decline, indicating the economy is no longer decreasing the most basic cost to maintain itself: energy.

To me, understanding social issues (income inequality and labor relations, economic growth rates, debt levels, getting off the gold standard in the 1970s, etc.) starts with understanding how changes in socio-economic trends are affected by this long-term trend of energy and food costs. If an economic framework can’t do that, then what use is it?

E4F: Why should economists pay attention to net energy metrics?

CWK: The short answer is that net energy ratios relate inversely to monetary cost of energy.  

The most popular name for a net energy ratio is “energy return on energy invested”, or EROI, to translate to the concept of monetary ROI.  

EROI = (energy production – energy invested by the energy industry) / (energy invested by the energy industry) = (net energy output) / (energy input), and it is a dimensionless ratio. The short-hand for the cost of energy is cost = (money input) / (net energy output), say in units of $/megajoule of energy.  

So energy output (sold) is in the numerator of EROI and denominator of cost. Thus, they are inversely related.  A lower EROI translates inversely to a higher cost.  This basic relationship holds for individual energy commodities and for the entire economy.

We still have some work to do in biophysical and ecological economics to clearly translate net energy metrics to macroeconomic metrics, so that we can better understand the dynamic feedbacks of transitioning to renewable energy that has different net energy characteristics than historical fossil fuels: an internal combustion engine car fuelled by gasoline from Spindletop oil well in Texas in the 1930s has a different characteristic than today’s electric vehicle powered by wind electricity. A cash flow or net present value calculation might just add the monetary cost inputs to compare them, but net energy analysis tells us more about the fundamental energy supply and conversion chain underpinning the economy.

E4F: Your book, ‘The Economic Superorganism’ makes the case that economic growth models based on neoclassical theory are incapable of distinguishing a 100% fossil from a 100% renewable energy future. Why is that?

CWK: I was primarily discussing the Solow-Swan economic growth model with exogenous technological change, but the same logic holds for endogenous growth models (that attribute some growth to additional human know-how) since they still usually have no explicit descriptions of energy resources extracted from the environment.

GDP is assumed a function of capital (K), labor (L), and the “exogenous technology” factor called total factor productivity (TFP). TFP is defined as the part of economic growth NOT described by capital or labor. Economists obtain data for K, L, and GDP, and then solve for TFP assuming that the equation relating them is true.  

There are three main problems: (1) The magnitude of change in TFP accounts for only about half of GDP growth, so the growth model explains only the other half. (2) To project future economic scenarios, economists project future TFP growth by assuming it continues similarly into the future (perhaps slowing down over time) no matter what happens to labor and capital. That is what it means to be “exogenous”. (3) There is no explicit description of energy.  However the original model formulation considered the value of “in the ground” energy resources as part of capital, and one can include energy as a conceptually similar factor as capital and labor.

A quote from my book summarizes the conundrum of these 3 items: “The result from most [integrated assessment models (IAMs) which almost exclusively use the neoclassical economic growth model] … is that no matter what, the economy always grows! Stay high carbon? Economy grows a lot. Going to zero-carbon emissions? Economy still grows a lot. The reason is that instead of assuming how the rate of investment and cost to convert to a low-carbon energy system affect economic growth, most IAMs generally assume economic growth first, via TFP, and decide later how many ways you can reconfigure the energy system.”

We have better theory. Research over the last 20 years has shown that TFP can almost entirely be described by the rate of change of efficiency of machines converting fuel (input) energy into work.

E4F: Your research seems to suggest that renewable energy transitions would fundamentally transform the character of the world economy. What would be the economic impacts of such transitions?

CWK: In at least two ways the ‘character’ will be the same. First, renewable energy, such as wind, solar, batteries, follows the general long-term trend to substitute human-made capital for labor and reduce operating costs, including that for energy inputs.

Also, the global economy (since 1970s) increases energy consumption more slowly than size, the same pattern as mammals and ultrasocial insects (ants and termites). As animals grow by increasing the number of cells, each cell (on average) consumes less energy. We face the same pressure. As the economy grows by adding another machine there will be less energy consumption per machine.

I think of the transition to 100% renewable and/or net-zero carbon as follows:

  1. The faster the transition, the more labor, energy, material flows and money get directed to the energy system for the up-front capital investment thus increasing energy expenditures (relative to GDP) — the opposite trend of industrialization discussed earlier — akin to a declining “dynamic” EROI. Thus, a rapid rate of transition might induce recession and/or a decline in household consumption by diverting so many resources to investment there is less for households. This dynamic is possibly why the transition is currently “slow” even though > 90% of studies (that neglect this dynamic feedback), such as cited by IPCC, indicate the transition is less costly and therefore can occur quickly (~ in 20-50 years) with a trivial effect on consumption (usually assumed a constant fraction of GDP).
  2. A 100% renewable economy will have a higher proportion of energy system costs attributed to capital (e.g., infrastructure). Fixed costs will be higher, operating costs lower, and the debate is how much those two offset.  Also, energy markets based on marginal operating costs will be less informative since consumers will pay mostly fixed payment for infrastructure independent of energy consumption.  Who owns and pays for the energy infrastructure becomes more important.

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