MAPPING THE REAL ECONOMY

Of what value are facts?

If this question arises with unparalleled force now, it’s because of the enormous, perhaps unprecedented divergence between the economy (and many other issues) as they are perceived and presented to us, and these same things as they actually are.

Starting with perception, the generally accepted narrative is that the Wuhan coronavirus pandemic is something which struck ‘out of a blue sky’, and could not have been anticipated. In due course, we’re assured, the economy will stage a ‘full recovery’, returning to pretty much its previous size, shape and direction, with monetary policy assisting this ‘return to normal’. Even the lasting damage inflicted on the economy can be made good over time. Life must go on, especially in politics, whilst most of the West’s incumbent regimes are making a pretty good fist of handling the pandemic-induced crisis.

This ‘consensus’ line on our current predicament is wrong, in almost every particular. Far from being unpredictable, the pandemic was anticipated by leading scientists whose prescient advice is, for the most part, still being ignored. Any economic ‘recovery’ from here will be largely cosmetic, the shape of the economy is going to be very different indeed, and monetary gimmickry can no more rehabilitate economic prosperity than central banks can ‘print antibodies’. Conventional, ‘business as usual’ party politics matter very little in this situation, and incumbent governments are, in general, making an unholy mess of the coronavirus crisis. When you look at what’s unfolding in, for example, Britain and America, you very literally ‘couldn’t make it up’.

A bad time for reality?

This situation – in which perception and presentation are at a premium, and factual analysis at a hefty discount – is not propitious for the subject-matter of this discussion, which outlines new developments which enable the SEEDS model to map the economy and some of its broader ramifications, the latter including the environmental harm caused by economic activity.

Part of the problem, of course, is an established insistence on the fallacy that the economy is a wholly monetary system, from which it follows that energy is ‘just another input’, and that “[t]he world can, in effect, get by without natural resources”.

Had Daniel Defoe’s Robinson Crusoe, shipwrecked on his desert island, only known about classical economics, he wouldn’t have wasted his efforts finding water, food, firewood and shelter, but would instead have spent his time accumulating bits of coloured paper. Indeed, had computers existed in 1719, he wouldn’t even have needed the paper.

In challenging this absurdity, those of us who understand that the economy is an energy system, and not a financial one, can sometimes feel as isolated as Robinson Crusoe himself. Some comfort can be drawn, though, from the reflection that reality usually wins out in the end, and that pre-knowledge of the outcome has considerable value.

The energy economy

The energy interpretation of the economy is simply stated, and need only be reiterated in brief here for the information of anyone new to the logic of Surplus Energy Economics.

First, all of the goods and services which constitute the economy are products of the application of energy. Nothing of any economic value (utility) whatsoever can be supplied without it. An economy cut off from the supply of energy would collapse within days. (If they were denied energy, conventional economists would lose the ability to publish learned papers telling us how unimportant energy really is).

Second, whenever energy is accessed for our use, some of that energy is always consumed in the access process, meaning that it’s unavailable for any other economic purpose. This ‘consumed in access’ component is known here as the Energy Cost of Energy, or ECoE, and its roles include defining the difference between output and prosperity.

Third, money has no intrinsic worth, and commands value only as a ‘claim’ on the output of the energy economy. Creating monetary claims that exceed the delivery capability of the economy itself must, therefore, result in the destruction of the supposed ‘value’ represented by those excess claims.

To be clear about this, money is a valid subject of study, so long as we never allow ourselves to be persuaded that to understand the human artefact of money is to understand the economy. Likewise, studying the lore and laws of cricket may be rewarding, but it won’t help you to understand a game of baseball.

The importance of this very different way of understanding the economy is that it points to conclusions drastically at variance from the comforting narrative generally presented to us.

Well before the coronavirus pandemic, it was evident that prior growth in global average prosperity per person had gone into reverse, and that we were encountering limits to the ability to use financial manipulation to disguise economic deterioration in the advanced economies of the West. The narrative of an ‘economy of more’ – more “growth”, more vehicles on the world’s roads, more flights, more consumption, more profitability and more use of energy – was already well on the way to being discredited. The pandemic crisis merely accelerates trends that had been evident for quite some time.

Critically, this process invalidates a raft of assumptions and of expectations founded entirely on the false presumption of ‘growth in perpetuity’.

Mapping the real economy

From the outset, the aims of the SEEDS model were (a) to interpret the economy from an energy perspective, and (b) to present this interpretation in the financial language in which debate is customarily conducted.

Development of SEEDS has reached the point where the reality of the energy-driven economy can be mapped. This can best be understood if it is stated as an ability to answer a string of critically-important questions, of which the following are examples.

First, how much economic value do we extract from each unit of primary energy that we consume, and where is this conversion efficiency relationship heading?

Second, from the value thus generated from the use of energy, how much ECoE must be deducted, now and in the future, to define the amount available for all other economic purposes?

Third, what can trends in ECoE tell us about the quantity and mix of energy likely to be available to us in the future?

Fourth, how, using this knowledge, can we best maximise prosperity whilst minimizing the environmental harm caused by our use of energy?

This list helps identify a short series of questions of which most can now be addressed as equations. These equations, together with a number of supplementary measurements, can be used mathematically to map the ‘real’ economy of energy and the environment in a way that can be pictured representationally as follows.

The equations

The following summary, though it doesn’t go too far into dry theory, is intended to provide an overview of the SEEDS mapping process.

Equation #1: measuring output

To calibrate the efficiency with which we turn energy use into economic value, we need to start by identifying a meaningful measure of economic output.

GDP cannot serve this purpose because it is subject to extreme monetary distortion. Essentially, reported “growth” is exaggerated by the use of credit and monetary activities which inflate apparent activity. The funding of anticipatory activity, and the inflation of the supposed value of asset-related transactions, are two of the ways in which this happens.

Reflecting this, reported average GDP “growth” of 3.6% between 1999 and 2019 was a direct function of net borrowing which averaged 9.8% of GDP over the same period.

Examination of the processes involved enables the calibration of this distortion, thereby identifying rates of growth in underlying or ‘clean’ output (C-GDP), which are far lower than their reported equivalents. The right-hand chart in fig. 1 illustrates how the insertion of a ‘wedge’ between debt and GDP has inserted a corresponding distortion between reported and underlying economic output.

Fig. 1: economic output

Equation #2: calibrating economic efficiency

Measured on the basis of C-GDP, economic output per tonne of oil equivalent (toe) of energy consumed has declined steadily, from $7,400 in 1999 to $6,730 last year, reflecting the observation that C-GDP has increased by only 40% over a period in which primary energy consumption expanded by 54%.

This deterioration in conversion efficiency may seem counter-intuitive, but has several important inferences, in addition to the obvious statement that we are using energy less, rather than more, effectively over time.

Specifically, changes in the ‘mix’ of the energy slate seem to be trending towards lesser conversion efficiency, whilst technology has concentrated much more on finding additional applications for energy than on the more efficient use of energy itself.

Fig. 2: economic efficiency

Equations #3 & 4: ECoE and volume

Trend ECoEs have been rising since a nadir that was enjoyed in the two decades or so after 1945, a period that also – although this was no coincidence at all – witnessed remarkably robust growth in world prosperity.

Latterly, though, a relentless rise in the ECoEs of fossil fuels has driven the overall trend sharply upwards. Optimists believe that the steady fall in the ECoEs of renewable sources of energy (REs) will solve this problem, but this expectation owes far more to hope and extrapolation than it does to realistic interpretation.

Though ECoEs play a critical role in the conversion of economic output into prosperity, they are relevant, too, for the quantities of energy likely to be available to the economy in the future. Hitherto, the consensus expectation has been that energy supply – including the amounts provided by fossil fuels – will continue the steady growth experienced in the past. In comparison with recent levels, this consensus sees us using 10-12% more oil, 30-32% more gas and about the same amount of coal in 2040, with total primary energy supply rising by about 20%.

The reality, though, is that a combination of two factors, both of them related to rising ECoEs, is starting to exert adverse effects on the volume outlook. First, rising costs are increasing the prices required by producers. Second, the upwards trend in ECoEs is, by undermining prosperity, reducing the amounts that consumers can afford to pay for energy.

Accordingly, SEEDS has now adopted a much more cautious scenario which projects little or no growth in aggregate energy supply, combined with a steady decrease in the availability of fossil fuels.

You’ll appreciate at this point that, if energy volumes cease growing, and if conversion efficiency fails to recover, then real annual economic value output can only trend downwards.

Fig. 3: ECoE and energy supply

Equation #5: measuring prosperity

Properly understood, the economic output value that we derive from energy is not the same thing as prosperity, because the first call on this output is the cost component – ECoE – required for the provision of energy itself.

ECoE defines a proportion of output which, being required for energy supply, is not available for any other economic purpose. Accordingly, the deduction of ECoE from output determines prosperity, whether this is expressed as an aggregate or as a per capita amount.

At the aggregate level, rising ECoEs have inserted a widening wedge between underlying output (C-GDP) and prosperity. Since the rate of annual progression in aggregate prosperity has now fallen below the rate at which population numbers continue to increase, world prosperity per capita has now turned downwards from a lengthy plateau, with the coronavirus crisis seemingly accelerating the pace of deterioration.

Regionally, prosperity per capita in almost all Western advanced economies has already been trending downwards over an extended period, which helps explain why so many of these economies have long seemed moribund despite the increasing use of financial manipulation to present a semblance of continuing “growth”.

This might even make us feel some sympathy for politicians who feel obliged to offer voters “growth” when, on the only criterion that really matters – prosperity – growth has ceased to be feasible.

In the EM (emerging market) countries, prosperity growth was already, pre-pandemic, decelerating markedly towards an inflection point anticipated by SEEDS to occur between 2020 and 2022. This climacteric may have been brought forward by the coronavirus crisis.

Fig. 4: ECoE and prosperity

Equation #6: economics and the environment

Though global temperature changes (and their causation) remain to a certain extent controversial, broader consideration, taking into account issues such as ecological loss and air quality, make it clear that human activity is harming the environment. By ‘activity’, of course, is meant the use of energy, and it’s surely obvious that we can only co-relate economic and environmental considerations if we place energy use in its proper place as the factor common to both.

Artificially-inflated measurement, such as recorded GDP, not only exaggerates apparent prosperity, but also supplies false comfort over environmental trends. As shown by a comparison of the period between 1999 and 2019 on a global basis, the false metric of GDP can be, and often is, used to assert that we are increasing the quantities of economic value achieved for each tonne of climate-harming CO² emitted into the atmosphere. Rebased to a C-GDP basis, however, it becomes apparent that CO² emissions have expanded by 48% whilst underlying economic output has increased by only 40%.

Moreover, rising ECoEs are worsening the relationship between prosperity and environmental harm. Critically, CO² emissions are related to gross amounts of energy used (including ECoE), whereas net amounts (excluding ECoE) determine prosperity.

Fig. 5: The environmental dimension

Equation #7: deviation from the real

The final mapping equation – in fact, a set of equations – cross-references the economy as it is to the version of the situation as it is presented to us.

Essentially, two components intervene between underlying prosperity and the version presented to the public as GDP. The first of these is ECoE, which conventional econometrics ignores. The second is the credit effect which arises where monetary policies are used to promote anticipatory activity, and to inflate the apparent value of asset-related transactions (as well as inflating asset values themselves).

SEEDS analysis enables us to quantify these distortions, and this, amongst other things, helps us to identify the adverse leverage in the mechanisms by which faltering prosperity is represented as expanding output.

From a purist perspective, this is something that we might ignore, concentrating our efforts on the identification of the ‘fact’ of prosperity.

In practical terms, however, this disparity is of the greatest importance, because it identifies the widening gap between semblance and substance.

For anyone engaged in economic planning – whether in government, in business or in finance and investment – it can be argued that this is the most important equation of them all.

Fig. 6: reality and presentation