Plus ca change, plus c’est le meme chose
— an old saying
And what rough beast, its hour come round at last,
Slouches towards Bethlehem to be born?
— from The Second Coming, a poem by W. B. Yeats
It is hardly an exaggeration to say that humanity has reached a fork in the road, and future generations await our decision. Our energy & economic prospects are at stake, and these two necessities are inextricably linked. At such turning points, it is natural for apprehension to cloud our judgment. We want to hang on to what we have, or improve upon it, but our uncertainty is greater than our ability to discern the long-term future. The only things that seem clear are that the future will not resemble the past, and must not resemble it.
Today I make some elementary but crucial observations about the relationship between fossil fuel energy and economies. I go on to question normal assumptions about future economic growth.
A revolutionary idea about energy and economies which is meant to banish our uncertainty and apprehension has taken hold among our decision-makers and elites. I call it the Radical Hypothesis (Figure 1).
Figure 1 — A conceptual depiction of the Radical Hypothesis. Economic growth (dotted line) has always been accompanied by growth in CO2 emissions (black line). Emissions are a proxy for fossil fuels consumption. Now, at the Turning Point, economic growth diverges from emissions growth. A third alternative, a reduction in the carbon intensity of economic growth, is also shown (dashed line). Carbon intensity is “a measure of how much carbon equivalents (CO2e) are emitted per capita of GDP.”
The decoupling of economic and emissions growth after the Turning Point is not usually seen as a radical departure from the norm because it is now the consensus view. I have intentionally turned this generally accepted view on its head to put it in clear perspective.
Given the historical trend shown in Figure 2, we might plausibly expect an outcome like that shown in Figure 3. I call this the Conservative Hypothesis.
Figure 2 — Taken from How Can We Reconcile Growth, Emissions and Resources? by Simon Roberts. The slides from his presentation can be found here. Emissions shrink during recessions and grow otherwise. No doubt a similar decrease is happening now during the Great Recession (2007-?).
Figure 3 — A conceptual depiction of the Conservative Hypothesis. At the Turning Point, shrinking emissions (black line) are accompanied by shrinking economies (dotted line). Economic abatement does not necessarily follow emission reductions due to technological progress (see below). Thus, the economic growth curve might be flatter or steeper, but the global economy (GDP per capita) must diminish in the conservative view if fossil fuel energy declines.
At issue is the true nature of modern civilization’s relationship to fossil energy. What we know historically is expressed in proposition (1).
(1) If the global economy grows, then CO2 emissions grow
It follows that—
(2) if CO2 emissions are not growing, the global economy is in recession (like now).
It is not the case that—
if CO2 emissions grow, then the global economy grows
because emissions could rise for all sorts of reasons unrelated to economic growth
The consensus, politically-correct opinion, represented (for example) by Al Gore or Obama’s science adviser John Holdren, says that a past tight correlation between economic and emissions growth does not necessarily imply that modern economies are utterly dependent on burning fossil energy to fuel growth. The Radical Hypothesis says you can have your cake (grow the economy) and eat it too (reduce emissions).
Logically speaking, the radical position contradicts proposition (1). It thus goes against our historical experience. The Conservative Hypothesis takes our previous experience (Figure 2) at face value—reducing emissions will reduce economic growth. You can not have your cake and it eat too. This is very much a minority view.
The Radical Hypothesis rests upon the complex assumption (3).
(3) Technological progress marches on and improvements are always sufficient to meet our needs (including our need for energy)
At the Turning Point, and “forever” after, technological improvements permit the decoupling of economic growth from fossil fuels consumption. For example, wind or solar replace coal, biofuels replace oil, etc. Net energy calculations (EROEI) don’t matter because they are based on present science & technology. Technological improvements will enhance energy extraction efficiency in all areas (e.g. in biomass to liquids conversions, or even in exploitation of oil shales, should it come to that).
Some taking the conservative view reject assumption (3) outright—we have run out of technological solutions to our energy predicament. Others grant that some technological progress will take place, but reject the notion that such progress will be sufficient to break our dependency on fossil fuels to achieve economic growth (proposition 1). The latter expresses my own view.
Our expectation of reduced CO2 emissions over time is due to two factors:
- fossil energy limits (i.e. the peak of oil production rates, and peaks in natural gas and coal production some unknown number of decades hence)
- pro-active measures taken to reduce emissions to mitigate climate change (e.g. policies that encourage switching to renewable “clean” energy sources, a moratorium on new coal-fired plants and a phase-out of old ones, and so forth)
Those adapting the Radical Hypothesis either deny that limits on exploitable fossil energy exist, or adopt the fall back position that fossil fuel resources don’t matter due to the inevitable dominance of “clean” energy made possible by technological progress. If resource limits do not exist and or pro-active measures are not taken—or don’t work because technological progress comes up short—we get a business-as-usual (BAU) scenario as shown in Figure 4. In this case, future economic growth would be taken for granted because nothing has changed.
Figure 4 — A business-as-usual (BAU) scenario. In this case, the best science available assures us that humanity faces a climate catastrophe in this and coming centuries. The BAU scenario is impossible if 1) prompt (between now and 2040) resource limits exist or 2) technological improvements do indeed come to the rescue. Assuming CO2 emissions rise at a rate of 2 ppmv/yr, we will reach 450 ppmv (parts per million by volume) in the atmosphere in 2041 (from ~386 ppmv now). Alternatively, the world might follow a reduced carbon intensity path (as shown in Figure 1) whereby carbon emissions grow at a slower rate. The science says that such a reduction will help, but not enough to avoid dangerous anthropogenic interference with the climate (e.g. we will get catastrophic sea level rise).
I’ve only scratched the surface of interlinked economic & energy problems in this brief introduction. Let’s explore another facet of the Radical Hypothesis.
Discounting the Future
Human beings discount the future, whereby “society places a lower value on a future gain or loss than on the same gain or loss occurring now.” And so do economists because—
If people’s preferences count and if people prefer now to the future, those preferences must be integrated into social policy formulation. Time-discounting is thus universal in economic analysis, but it remains, as it always has, controversial.
In 2005 the British Government asked Sir Nicholas Stern to review the economics of climate change. The end result of Gordon Brown’s request was the Stern Review on the Economics of Climate Change published in late 2006.
To my knowledge, no comparable review has ever been carried out to work out the economics of resource depletion. The so-called Hirsch report comes closest, but this document has neither the scope (in terms of economic analysis among other things—Stern’s report is more than 576 pages long) nor the weight of a report specifically requested by (then) British Chancellor Gordon Brown. This omission is not an accident. It follows from the general acceptance of the Radical Hypothesis (Figure 1), which does away with our need for ever-greater amounts of fossil energy to fuel economic growth.
Stern’s conclusions were (and still are) controversial because he used a very low discount rate, as explained in Frank Ackerman’s The Stern Review vs. its Critics: Which Side is Less Wrong? Ackerman’s review, along with Figure 5, provide a simple but good-enough introduction to discounting in general and how it relates to climate change in particular. I thus quote Ackerman at length—
… In Stern’s view, inaction on climate change would lead to damages worth at least 5% of world output per year, and, depending on how the damages are calculated, perhaps as much as 20%. Most of these damages could be prevented, according to Stern, by spending 1% of world output annually on mitigation…
The discount rate is central to the economics of climate change. When costs are incurred to reduce emissions today, the benefits of reduced climate change will occur decades or centuries later. How much less valuable are those benefits, because they will happen in the future? At a discount rate near zero, future benefits are almost as valuable as if they occurred today, implying that it is “worth it” to take action now to secure those future benefits. At a high discount rate, future values fade rapidly into insignificance, implying that very little climate mitigation is “justified” by its (heavily discounted) benefits in generations to come.
Economic theory distinguishes between two components of the discount rate: the “rate of pure time preference” that would apply if all generations had equal incomes; and a growth-related rate, assuming that if the future will be richer than the present, then there is less need to make investments on their behalf today.
Stern endorses the philosophical argument that present and future generations are of equal ethical standing, implying that pure time preference should be zero. Your granddaughter is no less important than your daughter simply because she will be born a generation later. Other economists frequently object that people display impatience and short time horizons at a level incompatible with zero pure time preference. Moreover, a rate of precisely zero causes technical problems in some economic theories. Perhaps to avoid this technical issue, Stern introduces a miniscule rate of pure time preference, 0.1% per year, based on an arbitrary estimate of the annual probability that the human race will not survive.
Like other economists, Stern includes a second part of the discount rate, tied to economic growth. His discount rate thus becomes the rate of growth of per capita consumption, plus 0.1%. Since economic growth averages 1.3% in his model, his discount rate averages 1.4%. Other economists assume both a more substantial rate of pure time preference, and a larger growth-related component, yielding discount rates as high as 6%. The difference this makes is enormous: $100 of benefits 100 years from now would be worth $25 today at a discount rate of 1.4%, versus $0.25 at 6%. In short, economic analysis can “see” much more of the future at a discount rate as low as Stern’s, but becomes myopic at a rate as high as 6%.
[My note: so, the discount rate = the rate of pure time preference (0.1%) + the economic growth rate (1.3%) = 1.4%/year.]
[My note: I emphasize the “arbitrary estimate of the annual probability that the human race will not survive.”]
Figure 5 — From The Ethics of Climate Change by John Broome, Scientific American, June, 2008. William Nordhaus of Yale is one of Stern’s severest critics. As the image text states, his “6 percent discount rate places far less value than Stern’s rate of the well-being of future generations.”
Before examining Stern’s low discount rate, let’s make sure we understand the answer to a key question: why discount future goods & services at all? Ackerman alludes to a “future … richer than the present.” John Broome, cited in Figure 5, fills in some of the details—
The Richer Future
Why discount future goods at all? The goods in question are the material goods and services that people consume—bicycles, food, banking services and so on. In most of the scenarios predicted for climate change, the world economy will continue to grow. Hence, future people will on average possess more goods than present people do. The more goods you already have, the less valuable are further goods, and so it is sound economic logic to discount them. To have one bathroom in your house is a huge improvement to your life; a second bathroom is nice but not so life-changing. Goods have “diminishing marginal value,” as economists put it.
I am more interested right now in Stern’s calculation of future economic growth at 1.3%/year than the laudable ethical stance implicit in his choice of a near-zero rate of pure time preference (see my remarks at the end). How did Stern arrive at this growth rate?
The stipulation of continuing economic growth is just what it appears to be—it’s an a posteriori (experience-based) assumption based on past growth in the 20th century. As Ackerman notes in a longer treatment of the Stern Review, the 1.3% average growth rate is one “plausible” choice among others—
This is not to say that Stern’s specific discount rate is precisely correct; it is hard to be confident of Stern’s 0.1% annual risk of global catastrophe, an admittedly arbitrary estimate. The 1.3% average growth rate of per capita consumption is plausible but far from proven to be correct. A balanced conclusion might be that Stern demonstrates that 1.4% is among the plausible discount rates – and that such low rates have profoundly different implications from rates like 5-6%, used in many other analyses.
Simon Roberts, who is referenced in Figure 3, provides some perspective on the unassailable presumption of continuing economic growth. Here are his informal remarks—
Economic growth. Actually, it’s quite a recent concept, because up until about a hundred years ago, the way that you get more money is by having more people or raising taxes, or invading other countries. It was only about a hundred years ago which is to say, you can actually produce greater value than you need merely for subsistence.
So, the idea of economic growth is comparatively recent. The last century is the economic growth century, really. What it means is that government policy is about encouraging economic growth, without encouraging a rise in prices, which means inflation. That’s the language of what we want governments to do, and the other point about it, it must continue. You can’t question the need for growth. Also, to leave the markets to sort out the appropriate mix between the factors of production, but the market is a way to achieve it and also technology will deliver….
So, let’s just see what the Stern Review, a year old, to see what Stern said about growth. How much should it be? Here’s an extract I found at about page 200, global GDP is around 2.9% on average for the last century. Therefore, projections for growth “to continue at that rate does not seem unreasonable”, and that’s it! That’s the only basis for picking that number 2.9%, but that’s what it says there. I can’t find anymore details about it within the Stern review.
[My note: The actual quote is on page 182 (chapter 7) and reads as follows: “But given that the growth rate of global GDP was around 2.9% per year on average between 1900 and 2000, and 3.9% between 1950 and 2000, projecting world growth to continue at between 2 and 3% per year (as in the IPCC SRES scenarios, for example) does not seem unreasonable.” Stern believes we should devote 1%/year of global GDP to mitigating climate, so we get the plausible but arbitrary value of 1.3%/year.]
[My note: My own view is that for almost all people throughout prehistory and human history before the 20th century, a standard assumption was that—outside the occasional disaster—future generations would be no worse off than the present generation.]
Let’s sum up.
- Mitigating climate change or overcoming limits on available fossil energy will require or force massive decreases in CO2 emissions over the 21st century.
- Economists assume future generations will be richer than the current one. Stern estimates economic growth in the 21st century to be 2-3%/year based on an average growth rate of 2.9% in the 20th century. Less the 1% devoted to climate mitigation, he comes up with a “plausible” average rate of 1.3% for the 21st century. The belief that economic growth is a necessity and will continue is not debatable.
- The conservative idea that 2.9% annual growth in the 20th century depended on a steady rise in CO2 emissions is rejected—this is The Radical Hypothesis.
- The assumption that economic growth in the 21st century growth will take place without an accompanying rise in emissions is justified by the stipulation that technological progress solves all problems as stated in (3) above.
There’s a whole lot of assuming going on here. The apparent contradiction is the use of a posteriori reasoning to justify future economic growth (#2), while rejecting such reasoning when evaluating the need for a concomitant rise in CO2 emissions (#3).
The $64,000 Question
It is far easier to envision shrinking economies in 2009 than it was in 2006 when William Nordhaus was criticizing Stern’s choice of a low discount rate in evaluating how much we must invest to fight climate change. Shrinking economies are driving lower emissions now, but it is not hard to imagine that lower emissions might constrain growth in the future. The Conservative Hypothesis (Figure 3) simply extrapolates past trends, and thus does not require a big leap of faith like the Radical Hypothesis (Figure 1) does.
Stern’s choice of a near-zero time preference in which future generations are valued as highly as the present one expresses an idealistic ethical stance. In reality, the present generation will always take care of its own needs before seeing to those of future generations due to the strong human preference for the here & now.
The climate science tells us we must invest heavily now to preserve a high quality of life in the future. Oil depletion tells us the same thing. Current actions (e.g. the pending Cap & Trade legislation) suggest that trying to preserve something close to the status quo is the path we will pursue. For example, we may follow the less carbon intensive path shown in Figure 1. See my essay The Reign of Error for some discussion.
Will we have economic growth in the 21st century? That’s the $64,000 question. I’ve described the Radical Hypothesis and the assumptions that underpin it. Whether you believe those assumptions will hold up over time is another matter. The relationship between energy and economy is complex. I could have called this introductory essay Energy & Economy 101. I should probably do some kind of follow-up talking about Exergy, the Cobb-Douglas function and the like and call it Energy & Economy 201—What A Mess! The problem is that they don’t often teach this stuff in school.
But that’s enough to chew on today. As newsman Ed Morrow used to say, good night & good luck.
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