Thursday, November 15, 2007

Week 14: Economics of energy in human systems

Hey everyone,
Please read the following paper for next week:

Hall et al. 2001. The need to reintegrate the natural sciences with economics. Bioscience 51: 663-673.

(recommended) Smil, V. 2000. Energy in the twentieth century: Resources, conversions, costs, uses, and consequences. Annual Review of Energy & Environment 25: 21-51. (at least look at graphs and highlighted sections, for which will need latest version of Adobe reader)



Figures: Electricity use for night-time

lighting at global, national, and
local (Albuquerque) scales
(click on figures for larger view)


Note: No annotations due this week (Thanksgiving week), but please post your blog comments.




**********************************************
Like organisms, human societies run on energy, and their energy use and characteristics scale with their size. At a minimum, societies need enough energy to fuel the bodily metabolisms of its members. As traditional foragers aggregate into larger groups, they require proportionately less land, suggesting that larger societies, like larger animals, metabolize energy more efficiently (Hamilton et al., 2007b). As people aggregate further, forming large urban settlements, their per-capita infrastructure costs continue to fall with population size, while their gross productivity and creative output rise (Bettencourt et al., 2007). As the average energy use of people along this spectrum increases, they tend to invest more energy in fewer offspring (Moses & Brown, 2003). In essence, a metabolic view of societies illuminates modern changes in human life-history tradeoffs at an individual level and, arguably, at a societal level.

This week, we will examine the role of energetic resources in fueling social metabolism and growth and on accounting for the central role of energy in human economies. It’s not required, but read the highlighted portions and graphs of Smil, 2000, if you have time. Smil, presents an eye-opening history of modern fuel use that shows the central role of external energy in fueling modern human society and social transformations & transitions. How might Smil’s account relate to Tainter’s ideas about high and low gain systems, Hollings ideas on adaptive cycles, and a general “systems” perspective on human ecology?

In arguing for integrating nature’s constraints into mainstream economics, Hall et al., 2001, provides a springboard for embedding hierarchical socio-economic systems within broader biophysical systems. Fig 2 presents a good view of this idea. We chose Hall not to launch a polemic against standard economics but rather to stimulate discussion on widening our systems perspective to include nature’s economy, especially the role of energy. From a geographic perspective, how do energy sources “map on” to the distribution of humans on the globe? Is a Diamondesque view helpful, that the geography of energy sources influences patterns of wealth and development? How are these sources distributed, both originally and through redistribution networks, and what are the implications?

Hall et al., 2001, also raise the issue of integrating ecology and economics, which have natural parallels and paradigms. Both ecology and economics come from the Greek “oikos,” meaning “house.” They share similar ideas of “capital” as wealth, monetary wealth in economics and the “embodied capital” of the body and its abilities in human evolutionary ecology. Ecology’s food webs are clearly akin to human economies of buyers, sellers, firms, and so on. And optimization plays key roles in life history theory (i.e. fitness maximization) and economic theory (i.e. utility maximization). A well-known ecology textbook encapsulates the ideas that natural systems run on energy and use it efficiently in its title, The Economy of Nature. As Brown et al. discuss in “The fractal nature of nature,” a scaling perspective of human ecology makes the same argument.

Given how wide-ranging the idea of valuing natural resources generally*, I’d rather focus on energy and build explicitly on our conceptual foundations in systems theory, scaling, and life history. Economists Herman Daly, Partha Dasgupta, Robert Constanza, and Kenneth Arrow, among others, have written extensively on the importance of proper valuation of natural resources and the related concept of sustainability. From ecology, H.T. Odum pioneered an energetic perspective, and C.S. Holling, Carl Folke, Lance Gunderson, and Stephen Carpenter have further developed “systems ecology” with humans and energy in mind.

We’re considering the value of a systems perspective of human ecology. How does it differ from traditional views? This macroscopic view uses scaling and hierarchy theory to backlight the often invisible networks that move and connect genes, energy, and information. It uses complexity theory to understand how nodes in these networks, such as actors on an agricultural landscape, use simple rules to generate emergent, systemic behavior. And it effectively uses economic theory to see how costs, benefits, and trade-offs connect individual decisions to global outcomes.

Looking forward to our discussion,

Bill


* See Daily et al. 2000. The value of nature and the nature of value. Science 289: 395-396 for a good general discussion of valuing ecosystem services written by a “who’s who” of ecologists and economists.

** If you're curious, here's a link to the New Mexico state profile from the U.S. Energy Information Administration, which has a wealth of information: http://tonto.eia.doe.gov/state/state_energy_profiles.cfm?sid=NM


13 comments:

Fred Whiteman said...

Does it make sense for Hall et al. to put so much emphasis on the inclusion of energy in economic models and then suggest a model which doesn't directly value raw materials (pg 668)?

Wenyun said...

Naive questions: What is different between neoclassical economics and classical economics? What is "water vs. diamonds" parodox?

dodegard said...

how could policies like those used in agricultural subsidies be used to include biophysical bases of the economy?

Justin Smith said...

Wenyun, the "water vs. diamonds" paradox is an example of the paradox of value: if water contributes more to survival than diamonds, why is the price of diamonds higher than the price of water?

The solution to this paradox that classical economists relied on, from Adam Smith through David Ricardo to Karl Marx, was to suppose that value of something is determined by the effort taken to produce it--mining and processing a diamond takes more labor, capital, and energy than collecting rainwater.

Neoclassical economics instead relies on the marginal theory of value--it is not the total usefulness of water or diamonds that matters but the value of one more unit of each, on the margins. Would you rather have one more glass of water or one more diamond?

Thus value is subjective in neoclassical economics, through the marginal value theorem as well as through utility theory which focuses on preferences and is the basis for the economic understanding of individual and social welfare. The marginal value theorem and utility theory together form the basis for the neoclassical concepts of supply and demand and equilibrium in markets.

Today Marxian economics is the subfield closest in form to the classical economics of old. Like good Marxists, Hall et al. implicitly rely on an intrinsic value theory rather than marginalism. Output, for example, should be measured by "the work performance and information processing necessary for its generation" (p.668), etc. As a result they neglect some basic results of simple supply and demand.

dtinucci said...

Although Hall et al. speak for Natural Sciences it seems appropriate to include Social Sciences in this debate, as our viewpoint also forms an essentrial position Economists need to take in account. For example; building on the work by Malinowski among the Trobriand Islanders, Karl Polanyi's "The Great Transformation" (1944) pursued a cultural approach to economics and by introducing the concepts of redistribution, reciprocity and exchange exposed the idea that economic relations were defined by social relations. In other words, since our energy consumption rests on such social values as status, power, etc. changing our social norms would be the first step in redesigning our lifestyles to accomodate a more realistic level of energy consumption.

tlvandeest said...

On p670, the authors discuss the fact that economies are not operating at absolute cost minimum due to the technological constraints on the process of automation, in which cheap energy replaces expensive labor. But wouldn't complete automation still need humans create, operate, maintain the machinery, thus never achieving the theoretical minimal cost? Also, if the model is to include the natural processes and energy that creates the products, is the energy and resources used in the creation of the automated machines also included in the cost of the production of the energy, rather than the labor wages previously calculated for the human workers?

Justin Smith said...
This comment has been removed by the author.
Justin Smith said...

In response to tlvandeest, I'm not sure where this automation stuff came from--it's not economics. Dividing production into automated production qt with "virtually no labor" and "labor-saturated" production (q - qt) completely violates the marginal principle and economic rationality. Any sort of near automation is only possible in their model because the implicit assumptions made by their choice of a Cobb-Douglass production function and its perfect substitutability of inputs. Notice that production is 0 if any of the inputs are 0, so all it requires is some infinitesimally small, "virtually" non-existent labor to use vast sums of capital and energy to produce output.

I'm not sure what they mean by "absolute cost minimum" either. In economic theory, a firm's problem of profit maximization given a budget constraint yields the same solution as a cost minimization problem subject to the constraint of producing a given level of output. Any absolute cost minimization is irrational.

You're right, they don't really account for the energy and materials embedded in capital and labor. These input factors, capital, labor, and energy, are highly inter-correlated, which is why you can't measure elasticities of production directly.

In other words, this absolute cost minimal "state of total automation" is a straw man derived from particular and unrealistic assumptions they've made and not from any economic theory or empirical observations of reality. As a result many of their predictions are quite laughable and easily disproved empirically. If making energy more expensive really lowers unemployment, for example, we'd be hearing about how many jobs are being created by near $100/barrel oil.

Michael said...

Hall and colleagues criticized the infrequency of empirical testing of economic models before their introduction. How would one go about empirically testing a large scale economic model before implementing it?

Justin Smith said...

Removed and reposted to correct a minor error:


The "fundamental assumption of neoclassical equilibrium economics" for which Hall et al. purport to find contradictory evidence isn't very well spelled out in the paper, and I'd like to make it a bit more explicit.

The limit myth of neoclassical economics is perfect competition, an equilibrium where no producer or consumer has the power to influence market prices and firms earn zero profits--all revenue from selling an output goes to pay for factor inputs. At this hypothetical equilibrium, firms are assumed to follow the marginal principle and purchase inputs unit by unit so long as the cost of each additional unit of each input is not more than the additional revenue gained from the associated increase in production--purchase more inputs and produce more so long as it is profitable to do so. In other words, at equilibrium the firm adds inputs until the marginal product of each input j equals the cost of that input, MPj = pj.

By definition, MPj = pq * (@q / @xj), where pq is the sale price of output q and xj is the amount of factor j used in the production of q (xj = k, l, or e). The partial derivative (@q / @xj) is how much the output q changes as the amount of factor input j changes by one unit.

Rearranging:
(pj / pq) = (@q / @xj) at equilibrium. Multiply both sides by (xj / q) and rearrange, such that (xj / q) * (pj / pq) = (@q / @xj) * (xj / q).

The elasticity of production as used by Hall et al. is defined by Ej = (@q / @xj) * (xj / q). Thus, at equilibrium, Ej = (pj / pq) * (xj / q). This can be rearranged to Ej = (pj * xj) / (pq * q).

Define the factor cost share for input j as sj = (pj * xj) / (pq * q). This is simply the percentage of the sale price that is used to purchase the input j.

Tada, Ej = sj. At equilibrium, the elasticities of production for each input will be equal to their respective cost shares.

So does the assumption of neoclassical equilibrium hold? Most economists wouldn't presume so, for a number of reasons. Tyner and Tweeten (1965, Journal of Farm Economics, 47:5 p. 1462-1467) which first laid out the empirical methods for such empirical estimations recognized their work was valid only under the "dubious assumption that economic equilibrium prevails" (italics added). Skepticism on this point is not new.

So why do economists even bother with such estimations? In practice, direct estimation of elasticities of production is infeasible because of intercorrelations between factors. An indirect measurement is the best we can do. But there's a bigger issue here.

The real problem in their model is in aggregating the production of scores of thousands of firms into one country-level production function. Consider 2 firms with the same production technology but free to use different levels of input factors: q1 = k1^A * l1^B * e1^Y and q2 = k2^A * l2^B * e2^Y. It doesn't necessarily follow that q1 + q2 = (k1 + k2)^A * (l1 + l2)^B * (e1 + e2)^Y. It's a mathematical fallacy to apply the Cobb-Douglass at a macro level even if it applies to individual firms at a micro level.

There are also issues with the substitutability of inputs, which the paper admits (p.688). The Cobb-Douglass production functional form used by Hall ensures that the elasticity of substitution between inputs is equal to 1, that is inputs are assumed to function as perfect substitutes for each other, which violates the laws of thermodynamics and invalidates their whole point.

There are legitimate criticisms of traditional economic modeling and policy, but many positive steps have been taken since the often generation-old critiques cited by Hall et al. Meanwhile, the model employed by Hall et al. embodies a lot of the problems that economists have begun to move beyond. Policy-makers looking to use Hall et al. as a basis for decision-making should tread carefully.

Tracy Brannan said...

I found the Smil article very interesting especially the definition of a "Man with a six horse team delivers 5kW hour of animate power". Because organisms and cells are both ionic in nature a better look at electrical commonalities of organisms could add definition to the metabolic process. Have other studies been done on man or other organisms relating energy output of muscle groups; or, other life processes down to a cellular level?

Senorita Myra said...

How is Hall's paper received in scientific circles and economists circles? What do people really think about these theories? Factoring in the cost of so many types of energy and the movement of energy seems to be a very difficult thing, especially when humans are involved.

Justin Smith said...

Myra, as far as economics circles go, this stuff hasn't gotten much serious attention. Lindenberger's 2003 restatement of the empirical model geared more toward economists was only published as a working paper, so none of this has gotten by peer-review by economists.

You can judge for yourself the influence of Hall et al. by looking at citations to it via Google scholar, subtracting out the authors' many self-citations.

 
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