Energy security is back in the news. The US 5th fleet based in Bahrein protects the flow of half of the world’s oil exports through the Straits of Hormuz, yet nine-tenths of that output goes to Europe and Asia. Russia, already the world’s largest producer, wants to drill in the Arctic with no interference from Greenpeace. China wants to enforce exclusive rights to drill in the South China Sea. The Obama administration is under heavy pressure to allow a controversial pipeline to move oil from Canadian tar sands to refineries on the US Gulf Coast. Underlying all this activity is a simple fact: every barrel of oil that once cost $1 to find and produce in Texas or Saudi Arabia has to be replaced by another one that will cost more than $100 to find and produce. And the economy of every industrial country now depends on oil.
Why have the economists got it so wrong for so long?
The world economy is under-performing. The “recovery” from the financial crisis of 2008-9 is too slow (in terms of GDP growth and employment). Economists are in continuing disagreement over why and what should be done. The view usually set forth in the New York Times, to name an example, is that the TARP program of 2008 and subsequent “quantitative easing” (QE) was “too little, too late”, due to mistaken fears that inflation would erupt at any moment. True, the scolds have been consistently wrong about the immediate inflation threat. But neo-Keynesians assume that increasing stimulus, at the cost of further budgetary deficits, will accelerate GDP growth enough to keep the future cost of debt service at a tolerable level. It worked in the past.
But if cheap money doesn’t do the job, or does the wrong job (financing risky investments that cause yet another bubble) what then? Even a Keynesian optimist must acknowledge that a future of steadily increasing debt/GDP, without limit, is not possible. This is the conservative justification for a policy of budget-cutting and “austerity”.
But what if the deficit-cutting, as recently experienced in Greece, Ireland, Portugal and Spain, doesn’t do the job either? Some will argue for still more austerity. But austerity punishes the young, the old, the disadvantaged and those least able to cope with adversity. Countries with youth unemployment near 50% have no more room for austerity. Social revolution followed by anarchy becomes an existential threat.
Why have the economists got it so wrong for so long? Larry Summers has noted the phenomenon of “secular stagnation” , meaning that the standard formula for accelerating economic growth by increasing spending (and borrowing) isn’t working as it used to. This is partly because a lot of the money spent for consumer goods in the US (and increasingly in Europe) goes to “emerging” economies (e.g. China), not to local workers. The stimulus to US and European economies is minimal. Another reason why cheap money isn’t creating jobs is that too many markets are already saturated. For most of the 20th century young boys and men dreamed of owning a car. Then, as they grew up, they wanted a little house with a picket fence, then perhaps another car for the wife and a bigger house and a vacation cottage at the beach. Manufacturing cars and houses and all the stuff that goes into a house employed a lot of people. But demand for those goods, by the middle class, is no longer increasing. Perhaps the smart i-phone and the i-pad are today’s equivalent of the model T. But, if so, the manufacturing jobs are in China or Thailand and the profits sit in a bank sit in the Cayman islands to avoid taxes.
Indeed, the middle class itself is losing ground, as Thomas Piketty has documented so thoroughly. More and more of us are pensioners, but the pension funds buy triple A bonds paying two and a half percent, thanks to cheap money and QE. This means that future pensioners are going to be poorer, unless the pension funds are allowed to buy equities, as Wall Street constantly advises. But, if past investment bank behavior is any guide, there will be another bursting stock market bubble soon. Where will it end?.
The elephant not in the room
I think the big missing piece (the elephant not in the room, so to speak) is energy. Cheap oil, the source of liquid fuels for all vehicles, is running out. The price of oil is much higher than it was a few years ago because new discoveries, whether from deep in the oceans, or from shale and tar sands, are very costly. They can’t keep prices going down any more. That is an economic headwind. But burning more fossil fuels thanks to even a feeble recovery, plus more growth in emerging economies, will also put more Greenhouse Gases in the atmosphere, making the climate problem worse. Climate change is already happening. That is another headwind.
What is needed to put the global economy onto a new growth track is an international project to make the petroleum-dependent internal combustion engine obsolete. The sooner the better. Obviously this requires investment, both for R&D and new production facilities. But there is no government money to spare in this day of fiscal frugality. Luckily most of the “new” technology that is needed is not really new. That is certainly true of wind turbines, solar power, smart grids, building efficiency and combined heat and power (CHP). These technologies can be improved. What really matters is that economies of scale and experience can, and will, bring renewable energy costs down dramatically.
I suppose a future with rising oil prices on the one hand but declining renewables costs on the other. In graphic terms it resembles a scissors, with a rising curve (hydrocarbon prices) and a declining one (renewables prices). That looks like an investment opportunity, for pension funds and insurance companies, with future obligations greater than their existing investment portfolios – heavily weighted by sovereign bonds paying very low returns – can expect to meet. Those are the same institutions that bought mortgage-based bonds and got hurt when the sub-prime mortgage house-of-cards collapsed. But today we have a potential source of great future profits by exploiting that energy price gap –the “scissors” — mentioned above. It should support investments producing real products and paying high returns. And luckily, too, plenty of money is sitting out there in sovereign wealth funds and “offshore” banks to evade taxes and waiting for something exciting to invest in.
What’s missing? I suggest that long-term thinking by investment advisors, hedge funds and money managers, plus some imagination, are the missing ingredients. A few “breakthroughs” here and there (e.g. improved electricity storage) will help. There is a technical problem to create tradeable investment securities to finance large-scale investments with high front-end costs but with increasing long-term returns. The potential exists for a new economic boom, not just a stock market bubble, without depending on government subsidies (although subsidies can help, too). Not only that, such a program could save the planet from overheating. Who’s game to start? Google? Apple? Microsoft?
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About the author:
Robert Ayres’s career has focused on the application of physical ideas, especially the laws of thermodynamics, to economics; a long-standing pioneering interest in material flows and transformations (Industrial Ecology or Industrial Metabolism); and most recently to challenging held ideas on the economic theory of growth.