The Breaking Point

by James Dale Davidson

  Neither J. S. Mill nor the green enthusiasts for CASSE seem to have recognized that the stationary state for organic agricultural economies, powered by somatic energy, does not translate to a steady state industrial economy—unless it were powered entirely by solar energy. Otherwise, anticipating or longing for a steady state industrial economy is nonsense. It is like calling for a steady state hovercraft, ignoring the fact that the hovercraft cannot levitate without fuel.

  The energy shortfall that collapses the progressive growth economy is equally subversive of the no-growth steady state economy. In this sense, the distinction between the two is without a difference: the depletion of oil reserves implies collapse, whether or not the aim is to grow GDP or keep it flat in a steady state.

  Mill ignored the biophysical constraints that could conceivably make for the stationary state. These require an economy living within the energy budget of current sunshine, without augmenting it through the consumption of energy capital. Mill says, “At the end of what they term the progressive state lies the stationary state.”

  Not today.

  I would suggest that, as seen in the Great Slowdown of the twenty-first century, at the end of the progressive state industrial economy is not the stationary state, but rather the retrograde or declining state. Unlike the circumstance imagined by the classical economists, there are not three states of an industrial economy, but only two: the progressive state (a growing economy) and the declining state (a retrograde economy) headed for the Breaking Point.

  Declining Marginal Returns

  Remember Baumol’s Disease, the condition in which the costs of the least productive sectors multiply faster than the economy grows? This affliction, which leads to low productivity activities absorbing an ever-greater share of resources, fatally complicates the fantasy of achieving a steady state economy.

  Here’s why. The US economy is afflicted with a number of sectors with chronically declining returns. These include the extractive industries, including oil and hard rock mining—sectors in which returns are diminishing primarily because we encounter natural limits as resources in the most easily accessed locations and concentrations have been depleted. In addition, there are also declining returns in sectors dominated by corporatist and crony capitalist distortions, such as medical care, education, and the military.

  The trend is for these radically inefficient sectors to require escalating energy inputs whether or not the deficient GDP measures expand or contract. Therefore the growth of the productive economy may be even more constricted by low energy inputs than a casual data scan would suggest.

  A great deal of energy is being wasted on unproductive activities.

  Education: An Ever-Less-Efficient Sector

  Consider the case of education. In principle, education improves productivity and should, therefore, pay its way. Once upon a time, it did. Now, not so much. In fact, I suspect that the slowdown in income growth after about 1973—itself reflecting the falloff in cheap oil inputs—stimulated a misguided attempt to improve economic prospects for nonelite workers at the bottom of the income ladder by prescribing a college education for everyone. As a result, the number of Americans going to college surged absurdly from 10 percent of high school graduates prior to World War II to about 70 percent in the twenty-first century. Not surprisingly, college tuition costs skyrocketed by 1,200 percent over the thirty years from 1984 to 2014.

  All told, as of 2014, Americans owed $1.2 trillion in student loans, with an average of $26,000 per borrower. With 3.8 percent interest, this translates to a monthly payment of $320. Lauren Asher, president of the Institute for College Access and Success, commented in a 2013 Forbes article, “Debt costs you time in savings, pushes back when and whether you can buy a home, start a family, open a small business or access capital.”13 Meanwhile, the returns on the investment in college have been declining. A report by Elise Gould for the Economic Policy Institute, “Even the Most Educated Workers Have Declining Wages,” details the fact that between 2013 and 2014, the greatest real wage losses were among people with a college or advanced degree. And over a longer period from 2007 through 2014, all education categories showed flat or declining real average hourly wages.14

  In short, the escalating costs of college education, while categorized as an investment, have begun to evidence sharply falling returns. They take a huge slug of inputs, including cash flow and energy, out of the economy, without returning as much as smaller outlays might. They well illustrate how inefficient sectors grow, absorbing more workers and resources, including crucial energy resources, without a commensurate return.

  Past the Threshold of Diminishing Returns

  We have reached and exceeded the point of diminishing returns in which the rapid depletion of readily found and produced cheap oil has created a conundrum of commercial practicability, as envisioned by Jevons. The lack of demand for high cost energy has led to falling prices, leading ahead to a potentially devastating lack of supply. Put simply, with low oil prices, oil companies cannot afford to commit to capital expenditure (CapEx) investment at a scale sufficient to keep global oil production expanding as a matter of “ever-increasing difficulty,” to quote Jevons.15 And this is not a problem that central banks can remedy. In the uncharacteristically sage words of Benjamin Bernanke, “Unfortunately, we can’t print oil.”16

  A century and a half ago, a mainstream economist clearly saw the economic importance of maintaining the growth in energy inputs. Today, his argument has fallen into a memory hole. This raises a number of issues for your attention:

  1. The evolution of views about the economy does not necessarily follow a logical progression. Every proposition that passes for received wisdom needs to be examined and reexamined for validity. In too many cases, what appears to be a “commonsense” truth is really bogus: a widely circulated misconception that gains currency because it flatters the ambitions or enhances the interests of powerful groups.

  2. Among those powerful groups, none is more powerful than the bankrupt nation-state itself. And you know it is bankrupt because none of the leading advanced nation-states can afford to pay legitimate normalized rates of interest on their huge sovereign debts. Nation-states have massive sovereign debts because they have outlived the conditions that gave rise to their growth and they no longer pay their way. Bankrupt or not, however, the government continues its traditional role in subvening the economics profession. As the scale of government grew, along with energy inputs, since the middle of the nineteenth century, the government became a major source of funds for bribing economists to rationalize and celebrate whatever politicians chose to do.17

  3. Our response to crises has an embedded pattern. Panic is followed by evermore extreme gestures at creating more fiduciary credit (“fictitious capital”). As economic growth has slowed, governments have become more eager, even desperate, to cultivate support for deficit spending and higher debt levels. Indeed, bailouts are no longer discrete events. They are chronic, structural interventions, involving the continuous creation of money out of thin air to preserve the feeble vital signs of a prostrate economy. Like a coma patient on life support, permanently attached to an IV drip, the economy survives only so long as the interventions continue. Leaving it to its own devices would be equivalent to pulling the plug—it would expire in a heartbeat.

  4. Apart from official concern about preserving and extending the debt supercycle, another factor distorting the mainstream narrative is civic myth. The conceit that government grew as a result of deliberate and informed popular choice, not as a second-order effect of geological accidents and the proficiency of petroleum engineers, blocks full appreciation of the role of energy in the economy.

  5. The long experience of exponential economic growth extending over many generations has contributed to an informal conviction that relatively rapid growth is the natural result to be expected. The expectation that growth at a twentieth-century pace can resume and continue indefinitely is taken for granted. Of course, th
is frames a paradox. If Jevons’s thesis is correct, as I believe, then the longer the period of high growth incorporating rising energy inputs continues, the more, rather than less, likely it is that growth will soon come to an end.

  In any event, I believe the declining energy intensity of the economy is indeed implicated in the financial stresses, debt defaults, recession, and the Great Slowdown, now construed as secular stagnation.

  Secular Stagnation

  The notion of secular stagnation—a condition in a market-based economy in which there is little to no economic growth—is another name for the stationary state, as reformulated in the 1930s by Alvin Hansen. It provides the servants of the establishment—like Larry Summers, the former treasury secretary and president emeritus of Harvard University—with yet another intellectual landmark on which to erect a billboard advertising a case that more government debt is required to reignite growth. Summers argues in a Business Economics article, “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound,” that there has been a “decline in the equilibrium or normal real rate of interest that is associated with full employment.” The solution, Summers tells us, is (what else?) more government spending financed by debt.18

  A Surplus Energy Equation, Not a Monetary One

  Summers postulates an “inverse Say’s Law: Lack of demand creates over time lack of supply.” I believe that something akin to this is indeed involved in the decline of the economy. But not in the way that Summers argues. Specifically, the problem is not monetary in nature, but biophysical. In Tim Morgan’s words, “The economy is a surplus energy equation, not a monetary one, and growth in output (and in the global population) since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy. But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel.”19

  The problem of long-term stagnation arises not from a lack of bank reserves but from insufficient reserves of cheap energy that make it practically impossible to double oil output again in the next seven to eight years (as Morgan tells us would be required to return to twentieth-century growth rates).

  What’s App?

  Of course, there are different ideas about the causes of secular stagnation. Summers frets that savings are too high relative to investment opportunities. He points particularly to WhatsApp and what he considers to be the alarming fact that it developed a greater market value than Sony with almost no capital investment.20 This takes us rather far away from what Adam Smith tells us in The Wealth of Nations, where the success of an entrepreneur’s efforts is “generally in proportion to the extent of his stock (capital),” implying that lower capital requirements would make for more success, not less. Smith also gives voice to the old-fashioned capitalist prejudice that funds for investment need to be previously accumulated—saved, that is, and not borrowed.

  The logic of Smith’s argument is that a declining requirement for investment should make for the more effective deployment of capital, not less. The investor who wishes to employ his capital with maximum effectiveness presumably prefers a situation like today’s in which significant new ventures can be seeded for magnitudes less capital than was required generations ago. While declining capital requirements might not please bankers, because they vitiate collateral and reduce the demand for credit, they should please entrepreneurs.

  You might argue that the surge of hundreds of billions in credit demand to finance stock buybacks is a partial response to a decline in perceived opportunities for large-scale investment in the physical expansion of industry and trade. But this only directs our attention to the next question: Why have opportunities for large-scale business investment receded?

  Witness the progression of Caterpillar’s stock buybacks in relation to capital expenditures. In Q1 2013, Caterpillar invested about $800 million, with no share buybacks. But by Q3 2014, in the midst of thirty-one consecutive months of declining retails sales, Caterpillar share buybacks took $2.5 billion and the company’s CapEx had dwindled to less than $500 million. Buybacks now exceed CapEx by five to one for this industrial bellwether. Where there is no growth, financial manipulation through share buybacks pays better than investment in industrial capacity.

  “Is US Economic Growth Over?”

  Professor Robert Gordon, who helped renew interest in secular stagnation in the wake of the subprime crisis, asked important questions in his 2012 paper “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds.”21 For an establishment economist, Gordon took a contrarian, or at least old-fashioned, view in respect to the well-conditioned expectation that economic growth is a continuous process that will persist indefinitely. Gordon wrote that there was “virtually no growth” before 1750 and there is no guarantee that growth will persist forever. He further stated that the “rapid progress made over the past 250 years could well turn out to be a unique episode in human history.”

  Gordon deserves credit for challenging the taken-for-granted assumption that economic growth is inevitable, yet you would look in vain in his analysis for a compelling explanation of the growth slowdown. Instead, Gordon blames “faltering innovation” and “six headwinds,” a collage of clichés that offers little in the way of insight into why economic growth might suddenly have stalled after two and a half centuries. While recognizing that there was no growth before 1750, Gordon stops short of utilizing that insight to explain the twenty-first century’s Great Slowdown.

  Accounting for Growth

  If you are a fan of econometric modeling, you will be interested in the work of economists Robert Ayers and Benjamin Warr, who have investigated the time series econometrics of growth models with some maverick results. In Accounting for Growth, they analyze economic growth since 1900, treating physical work as a factor of production and finding that it explains historical growth with high accuracy until the mid-1970s. They state, “In effect, the Solow residual (a number describing productivity growth) is explained as increasing energy-conversion (to work) efficiency.”

  A major contribution to growth is conventionally assigned to technological progress, something that, by its nature, is challenging to measure. Ayers and Warr propose resource inputs as factors of production, whereas conventional economics tends to treat resource consumption as a consequence of growth rather than as a factor of production. Whatever you may think of Ayers’s and Warr’s argument about energy as a factor of production, there is little doubt that our modern technological era has leveraged cheap energy for growth.

  In this respect, Professor Gordon seems to have missed a crucial insight underscored by energy analyst Gregor MacDonald. He puts together the loose pieces of innovation in the modern centuries into a coherent big picture in his article “Paper vs. Real: Exit from Normal, Ecological Economics, and Probabilistic Regimes in One Chart.” MacDonald states that even though human innovation and technology will continue, it will be limited to “small, incremental terms” based on the energy available. He goes on to say: “The advances made possible once humans started extracting fossil fuels, while likely to be repeated in humanistic terms, will not be repeated in industrial terms. Fossil fuels are not creatable. Their unique density made possible a whole range of laborious, constructive activities at a speed and scale that is not replicable.”22

  The Fantasy of Dematerializing the Economy

  Advocates of energy efficiency, ever eager to confuse the public about dematerializing the economy, or decoupling economic growth from the growth of energy inputs (and thus the dreaded carbon emissions) extol the supposed benefits of declining energy intensity in the United States. They miss the fact that, as energy use per capita has declined, so have real wages, along with the genuine prosperity of the American middle class. These are symptoms of the declining state. In fact, one of the simpler explanations for the deindustrialization of the United States is
that manufacturing was priced out of access to energy, leading energy intensive industries to move overseas. The push for energy efficiency was a major factor in the outsourcing of manufacturing.

  Energy Shortfall Coincides with Signal Crisis: Productivity Plunge and Income Decline for Bottom 90 Percent

  Bear in mind that the timeline that marks 1973 as the end of the rapid phase of energy input growth, associated with the postwar Great Prosperity, ties in with issues we explore in other chapters. For one thing, as indicated above, productivity growth sank after 1973. Robert Wiedemer put it this way: “Even the spurts of productivity growth in the 2000s don’t change the overall pattern of much slower growth after 1973.”23 Not coincidentally, 1973, when the postwar surge of energy inputs in the US economy petered out, was the year when the share of Americans living in poverty bottomed. Then the next year, 1974, saw the first general decline in wages in a quarter of a century. As documented in chapter 5, wages fell by 2.1 percent, while median household income shrank by $1,500.

  It is also notable that this proved to be the peak in the income share of the bottom 90 percent of earners. Soon thereafter the income share of the top 1 percent of earners bottomed out at about 9 percent and then began to soar. By 2012, it had more than doubled to 22.5 percent. These details underscore some of the dimensions of distress to which investors responded in triggering the signal crisis of US hegemony at that time: productivity growth collapsed, real income peaked, and broad-based prosperity began to recede. Richard Nixon had defaulted on the Bretton Woods commitments, and investors in droves turned away from business investments to place their free cash flow in financial assets.