This document summarizes a presentation given by Charles A. S. Hall and Kent Klitgaard at the Gulf Coast Economics conference in Houston in October 2005. The presentation argues that current economic models and textbooks do not adequately account for the role of energy and resources in economic production. It advocates for a new "biophysically-based" economics that recognizes the economy's dependence on natural resources and energy. The document outlines several key facts about energy use and production trends. It also questions mainstream economic concepts like efficiency, the role of capital in wealth creation, and the ability of markets to deal with long-term issues like resource depletion.

1. A biophysically-based
economics for the second
half of the age of oil
Charles A. S. Hall
State University of New York
College of Environmental Science and Forestry
Kent Klitgaard
Department of Economics
Wells College
Aurora, New York
Presented at Gulf Coast Economics conference
Houston October 7, 2005

2. What should we be teaching our young
people in economics courses?
 Is the world a different place now than in
the past several decades?
 We say yes
 If so, should we be adapting to that?
 We say yes
 Does our current generation of economics
textbooks reflect these necessary
adaptations?
 We say no

3. SOME FACTS:
 The economies of the United States, and
the world, run basically on oil, gas and
coal
 Liquid and gaseous petroleum provide
about two thirds of the energy we use in
the United States (and the world)
 Production of oil in the United States
peaked in 1970. Today we produce only
40 percent of what we did in 1970.

4.  Consequently the world and the U.S.
became increasingly dependent upon
petroleum
 Today two thirds of U.S. energy comes
from oil (nearly two thirds imported) and
gas, most of rest from coal
 New sources (except nuclear) remain
trivial and are decreasing as %

5. The US economy survives by using every one else’s oil

6. Global production in the world will peak (or
has peaked) relatively soon.
2004
U = 1800 BBO
Campbell and Laherrere (1998)

7. …because we are using 2-4 times
more oil each year than we find

9. We are not alone….
 The sea change currently taking place in
economic theory is revealed by the views of
recent Nobel prize winners in economics:
 Amyarta Sen and Daniel Kahneman were
recognized for their work critical of the rational
actor model
 Joseph Stiglitz and George Ackerman for their
work on alternatives to the standard model of
competition.

10. OUR FIRST QUESTION:
What is economics?
 Well we all know the answer:
 Economics is the study of the
allocation of scarce resources among
competing ends.

11. Standard view of inputs and
outputs to an economy (U.S. in
1990)
CAPITAL $5000?
U.S. Economy GDP $20,000?
(Average for one person for one year)
LABOR 2000 hours

12.  This is a social definition of economics:
 It implies that scarcity is only relative
scarcity, that humans are rational, that
firms, households and markets are all that
you need to make a legitimate economic
analysis or understanding.

13.  We all know that that is not true…..

14. AN EQUALLY LEGITIMATE VIEW
OF THE US ECONOMY

15. Other Metals 43
Water 140,000
Rock 81,000
Cement 349
Wood 1000
Lost soils
Iron 186
OIL 2500
CO2 89,000
COAL 3000 U.S. Economy
[Includes material and energy flows] PARTIC. 29
GAS 2000
(Average for one person for one year) SOx -- 84
HYDRO, NUC [KG/person/year] NOx -- 80
VOC -- 80
BIOMASS ETC
Polluted Water
toxins

16. Interdisciplinary Economic Model
Ecological & Physical Systems
Energy Economic System Waste Heat
Solar Households Firms Heat
Nat. Res. Pollutants

17.  Our second, quite different, definition of
economics comes from the great
Hungarian economic anthropologist Karl
Polanyi (Trade and Market in Early
Empires) who provided what he termed a
Substantive definition of economics:
 Economics is the study of how
people transform nature to meet their
needs.

18. Economic development is often a series of resource
booms and busts

19. Ecuador’s exploitation cycles

20.  For me economics is summarized as this:
 For every dollar you spend the energy
equivalent of roughly a coffee cup’s worth
of oil is spent somewhere in the world to
bring you that dollar’s worth of good or
service

21. OUR SECOND QUESTION
What is wealth and where does wealth
come from?

22.  Money is our usual measure of wealth, but
money is notoriously slippery:
 Printing more money does not make us richer,
but just leads to inflation.
 So some people think we should use a
“harder” measure, usually gold

23.  But when in the 1500s Spaniards
doubled the quantity of gold in
the old world– they halved its
value!
 The wealth was from the energy
used there: from the sun, rain
and wind and from the activity of
foresters, fishermen, farmers,
housewives, artisans etc who
did the physical work to
generate the wealth

24. Crustal Abundance of Minerals
100000 Aluminum
Iron
10000
Titanium
1000
Mananese
Vanadium
Zinc
100 Nickel
Crustal Copperr
Chromium
NiobiumCobalt
10 Lead
Abundance
Tin
1
TungstenMolybdenum
0.1
Silver
0.01 Platinum group
Gold
0.001
Tons rock per ton metal

25.  Gold is expensive largely because it is
rare in the Earth’s crust.
 It takes roughly 60 million Kjoules to mine
a Kg of Gold
 Expensive things are usually energy-
intensive

26. In the Classical/Marxist world view:
Wealth comes from the activity of labor

27. But labor is an increasingly small input relative to the
FUEL ENERGY that does the work of economic
production
100
80 Fuel
Labor
60
Percentage
40
Domesticated
20
Animals
0
1850 1890 1930 1970

28. In the neoclassical world view:
Wealth comes from Capital
(In the 1970s Solow dropped even
labor)

29. The Standard Economic Model
Consumption & Investment
Goods & Services
Households Firms
Labor & Capital
Wages & Profit

30. Neoclassical production functions--
e.g. Cobb- Douglass production function:
P = f(K,L)
“residual” assigned to innovation
Ignores the most important element!!!

31. When energy is included in production functions,
it explains the observed output with greater power
than does either capital or labor
Japan

32. Germany

33. United States

34. As natural scientists we believe that these
models of Neoclassical Economics:
-- Uses incorrect boundaries
-- Is inconsistent with Laws of
Thermodynamics
-- is largely based on articles of faith rather
than empirically validated science

35. It is neither labor nor capital that
generates wealth,
but NATURE
Including especially the energies used by nature
and also by humans to exploit nature
We need a new approach to economics:
Biophysical economics

36. Henrich et al.
 “Experimental economists and others have uncovered
large and consistent deviations from the textbook
representations of Homo economicus.
 Literally hundreds of experiments in dozens of countries
suggest that, in addition to their own material payoffs,
people have social preferences:
 subjects care about fairness and reciprocity, are willing
to change the material outcomes among others at
personal cost to themselves, and reward those who act
in a pro-social manner while punishing those who do not,
even when these actions are costly.”

37.  About half of the Nobel prizes in economic
in last two decades have gone to people
(Kaneman, Stiglitz, Sen etc.) whose
worked has undermined the basic
neoclassical model

38. Economic development is often a series of resource
booms and busts

39. This is how real economies work
Energy
Sources

40. This is how real economies work
Raw
Materials

41. This is how real economies work
Exploitation

42. This is how real economies work
Processing

43. This is how real economies work
Manufacture

44. This is how real economies work
Consumption

45. This is how real economies work

46. QUESTION III. ENERGY AND
ECONOMIC PRODUCTION

47. For most of its existence
the United States
Economy used energy
in almost direct
proportion to its GNP

48. How to have successful
development (Hall model)
Countries with
energy growth
greater than
population growth
become richer
Those whose
population
growth is greater
than
energy growth do
not

49. Hence we in the natural sciences, and
indeed any thinking person, MUST reject the
neoclassical model as a representation of
real economies.
It is a fairy tale

50. “Tell me the fairy tale about the economy.”

51. QUESTION 3
 Haven’t the earlier biophysical models
been negated?
 Remember:
 1) Barnett and Morse
 2) Paul Ehrlich’s Bet
 3) Limits to growth

52.  Barnett and Morse: No increase in the inflation-
corrected price of any major resource (except
forest products)
 ? Some circularity there …
 However Cleveland (Barnett and Morse
Revisited ) found that prices were kept low only
through the use of more and more energy, which
was becoming cheaper at that time.

53.  Paul Ehrlich’s (one of my heroes) stupid bet

54. 1972

55. The model
showed violent
oscillations
in the
conditions of
humanity

56. Economists did
not like this model
and attacked it
fiercely

57. “ A close look by economists has led many
competent independent analysts to conclude that
the underlying assumptions are pure fantasy
…did not refer to a single scientific study …
There is a clear possibility that the
development of nuclear fusion will open up a
vast and perhaps enormously cheap source
of power ..
There are no inventions .. Output per unit
input has been rising between one and
one half and three percent (Denison)…

58.  And since these oscillations did not come
to pass most economists believed its
results spurious.

59.  Discussion of any limits to growth disappeared Most who
thought about it said the market had solved the problem
 The oil issue has, until the last few days/months,
disappeared from the media
 Growth returned as the god
 Those who raised these issues were alarmists,
Casandras
 Even mpg goals were essentially eliminated
 There was not even any place to apply for money in NSF
or DOE (except for technical studies to produce more) to
study such issues
 The economists won the debate!!!

60. Economics has trumped science!
 Neoclassical economics, including
especially monetary cost-benefit analysis,
has become the overwhelming choice to
make public decisions.
 These ideas sometimes have become
conflated with the anti-government
conservative agenda
 “Let the markets make all decisions”

61.  But…. (a closely held secret):

62. As of 2005 the limits to growth model is almost
exactly correct for all parameters!

63.  In fact most biophysical predictions have been
right on:
 Oil production in US has declined by 60 percent
as predicted by Hubbert
 Huge price increases in 1980s resulted in less
O&G production subsequently
 Global oil production is at or near peak
 Most other resource issues have been bailed out
with cheap oil (soils, fish, water etc).
 NO substitutes for oil have emerged
 Renewables remain less than 1% (except hydro)

64.  Question 4. Efficiency
 Neoclassical economics is sold to the
world from the perspective of
“efficiency”
 In economics efficiency means that all productive factors are
optimally employed, and this should lead to lowest possible
prices
 So we tested that as science or engineering would:
Efficiency = OUTPUT / INPUT

65. We have published four such updated papers
showing same for most countries
Qua lit y c orre c t e d e ne rg y e f f ic ie nc y o f se le c t e d c o unt rie s , 1970- 1996 Kenya
Nigeria
100.0
Senegal
Zambia
90.0
Costa Rica
GDP in mil 1987/petajoules
80.0 Mexico
70.0 USA
60.0 Argentina
50.0 Brazil
Columbia
40.0
Venezuela
30.0 India
20.0 Korea
10.0 Malaysia
0.0 Philippines
1965 1970 1975 1980 1985 1990 1995 2000
Thailands
Netherlands
Ye ar

66. TESTING EFFICIENCY
Our Conclusion
We found NO evidence for 40 countries that efficiency of turning
energy, water or forests into wealth was increasing -- if
anything the opposite (possible partial exceptions US and
Hong Kong)
 (Ko et al 1998, Tharakan et al. 2003, Hall and Ko 2005).
Wealth comes from resource exploitation!

67. Some difficult economic things that
biophysical economics can explain
reasonably well:
 Labor productivity
 Phillips curve excursions
 Failure of development (some aspects)

68. What
Denison
missed

69. Phillips
Curve:
Theory

70. Phillips
Curve:
reality
1970’s

71. CONCLUSIONS
 Economics remains largely about
investing energy in exploiting nature
 This needs to be the first principal of
teaching economics, not something
marginalized.
 In the long run mother nature holds the
high cards

74. My final professional goal
-
Neoclassic
al
economics

75.  It is inconceivable to me that that the market or
conventional economics is providing useful
signals for foreseeing or dealing with these
issues.
 In fact by glorifying trivial and manipulated
tastes, by worshiping growth, by ignoring such
issues as population growth and resource
depletion, the market approach is greatly
exacerbating these very difficult problems

77. THE END

78.  Real economies are based on resources
 Economic development is usually a series
of developments, depletions and then
shifts to new resources

79. Economic development is often a series of resource
booms and busts

80. Ecuador’s exploitation cycles

81. Predatory (i.e. large) Fish –catch per
effort
Nature 423, 280 - 283 (15 May 2003); doi:10.1038/nature01610

82. We are NOT getting less
resource dependent

83. Costa Rica:
The myth of sustainable development
Results
 No silver bullets
 Vulnerable to oil prices
 No possibility of sustainability
for 20 reasons
 BUT: Good society on a
relatively poor resource base.
 Much to learn from Costa
Rica.

84. My Next Book:
Making Development work:
A new role for science
By Gregoire Leclerc and Charles Hall (Eds);
University of New Mexico Press (in press)
Two volumes:
1. Theory
2. National histories and case studies
Acessable at: http://www.esf.edu/EFB/hall/Extracredit/MDWF0.doc
(where 0 is 0 to 9)

85. Let’s not forget the environment
 There are often extremely costly “side”
effects:

86. International Relation Between
Economic Activity and Energy Use 1990
10
9
8
7
6
5
4
3
2
1
0
0 100 200 300 400 500 600 700 800 900 1000