On Wednesday 18th January we had another of our Energy Journal Club meetings. Sean was talking about Hamilton (2011) - Oil Prices, Exhaustible Resources, and Economic Growth, Jelte talked to Murphy & Hall (2010) - Year in review—EROI or energy return on (energy) invested, Sebastian covered Greene et al (2005) - Have we run out of oil yet? Oil peaking analysis from an optimist’s perspective, Erkal spoke to Hamilton (2005) - Oil and the Macroeconomy, and I talked about Holland (2008) - Modeling Peak Oil.
To summarise the Holland paper:
# It started from the usual no-arbitrage Hotellings condition (prices must move in such a way so that the owners of exhaustible natural resources are indifferent between: extracting the resources, selling them and investing the financial proceeds; and just sitting on the unextracted resources), but presented 4 models that were sufficient to generate a peak in production. You may have thought that since oil production started from zero in the mid nineteenth century and rose to the present day, and since oil is a finite resource, then any good model would show a peak in production. But most economic models of the oil market, including the basic Hotelling model, have peak production at time zero since this is when prices are lowest and demand is highest.
# The 4 models are models of cost reductions through technological change, demand growth, endogenous reserve additions, and site development. This last model in particular is novel to this paper, and is consistent with the story described in Hamilton (2011) - Oil Prices, Exhaustible Resources, and Economic Growth.
# I have two objections to this paper:
(a) It uses a partial equilibrium approach. This means that the interest rate, that the Hotelling mechanism says is the rate at which the oil price rises, is independent of the aggregate oil supply.
(b) It assumes that oil that is uneconomic to exploit now will be economic to exploit at a higher price. This ignores the possibility that the capital goods with which this future oil can be exploited do not change in price (or at least that their price doesn't rise faster than the oil price).
I'm being slightly unfair in my objections since the paper is following standard assumptions in the literature. However these objections essentially form the basis of my own work.
Tuesday, 31 January 2012
Sunday, 29 January 2012
Limits To Growth
The New Scientist recently had an article on Limits To Growth, and this week's issue features a letter from me in response to this article. They've edited my letter somewhat, the original is reproduced below:
"The article states that economists' objections were that future innovation was not included in the model. This is to misrepresent economists' concerns to a certain extent: what is missing from LTG are prices and incentives.
LTG is essentially a 'fixed factor' model so that output is associated with certain inputs. Assuming a path for output and some endowment of input factors, we can always make the model overshoot and collapse, no matter how abundant we choose these input factors to be.
Economic models on the other hand require that these inputs be purchased by the sectors creating output. Under standard assumptions, scarcity drives up prices - a continuously rising price may spur innovation, but if it doesn't then it will instead restrict demand. Rising prices incentivise innovation, substitution or a smooth contraction in activity. Because of this, it is quite hard to construct an economic model that displays overshoot and collapse i.e. in most economic models we are automatically in the 'stabilising scenario'.
I think LTG is likely to prove closer to the truth than e.g. the endogenous growth models with exhaustible resources of Dasgupta & Heal, Stiglitz, and Solow. However, this is not because LTG is right and economists are wrong. It is because prices and and incentives have not responded to the finite nature of resources in a manner consistent with a model with rational and perfectly foresighted agents. These are wrong assumptions in much the same way that a model without prices and incentives contains the wrong assumptions.
Non-economists will get nowhere in convincing the economists, by producing models that lack economic mechanisms and incentives. Instead economists and non-economists alike have to work together to tease out the correct economic mechanisms and incentives."
"The article states that economists' objections were that future innovation was not included in the model. This is to misrepresent economists' concerns to a certain extent: what is missing from LTG are prices and incentives.
LTG is essentially a 'fixed factor' model so that output is associated with certain inputs. Assuming a path for output and some endowment of input factors, we can always make the model overshoot and collapse, no matter how abundant we choose these input factors to be.
Economic models on the other hand require that these inputs be purchased by the sectors creating output. Under standard assumptions, scarcity drives up prices - a continuously rising price may spur innovation, but if it doesn't then it will instead restrict demand. Rising prices incentivise innovation, substitution or a smooth contraction in activity. Because of this, it is quite hard to construct an economic model that displays overshoot and collapse i.e. in most economic models we are automatically in the 'stabilising scenario'.
I think LTG is likely to prove closer to the truth than e.g. the endogenous growth models with exhaustible resources of Dasgupta & Heal, Stiglitz, and Solow. However, this is not because LTG is right and economists are wrong. It is because prices and and incentives have not responded to the finite nature of resources in a manner consistent with a model with rational and perfectly foresighted agents. These are wrong assumptions in much the same way that a model without prices and incentives contains the wrong assumptions.
Non-economists will get nowhere in convincing the economists, by producing models that lack economic mechanisms and incentives. Instead economists and non-economists alike have to work together to tease out the correct economic mechanisms and incentives."
Tuesday, 24 January 2012
Just Testing
Just testing whether I can put videos into this blog - but I'm sure there's an economics angle here: asymmetric information maybe...
Wednesday, 23 November 2011
The necessity of growth
Chris Dillow had a thoughtful post recently on why governments, and by extension the rest of us, really want economic growth. This post, indirectly, reminded me of Tim Jackson's 2009 book: Prosperity Without Growth. I didn't like it, even though I think that many of its conclusions are probably sound, the analysis is very weak.
In particular, Jackson sets up a straw-man of a ‘conventional macroeconomics’ in which GDP growth is necessary, and then shows that this is not ecologically sustainable. However it’s not clear that ‘conventional macroeconomics’ does require this: disappointed growth expectations may lead to recessions etc due to frictions, but if the central expectation of economic growth was zero (and debt levels etc were consistent with this expectation) then in what way would our ‘conventional macroeconomics’ require a positive growth rate? (I link back to Chris Dillow's post for some thoughts on why there may be such a requirement - but you won't find any such thoughtful analysis along these lines from Tim Jackson).
I think that the postulate of ‘a conventional macroeconomics’ is just a disparaging line of attack from someone who chooses not to engage with economics and wants to portray it as monolithic and wrong. See these links for other complaints along these lines.
It is clear that ultimate limits exist but it’s in no way clear that this precludes a capitalist system, because it is in no way clear that a capitalist system ‘requires’ growth.
Wednesday, 16 November 2011
Accounting for growth - Ayres & Warr
Interesting paper from 2005 published in Structural Change and Economic Dynamics: http://www.fraw.org.uk/files/economics/ayres_2005.pdf
This paper starts by noting that under normal assumptions, i.e. a constant returns to scale production function, changing factor endowments cannot explain the change in economic output over the 20th century. We need to postulate an additional factor: usually `technological progress'. This conclusion is qualitatively unaltered even if we expand the factors we consider from labour and capital to also include energy inputs.
However, if raw energy inputs are converted into `useful work' using estimated efficiency factors, then the change in labour, capital and useful work, at least over the 1900 - 1970 period, does seem to explain the change in economic output.
Is this an anodyne statement? Is every technological improvement basically just an improvement in the conversion of energy resources into useful work? Should we be surprised by this result? In particular, are we comfortable with idea that the productivity of labour has stayed constant and it's just that each unit of labour has more capital and joules to play with?
The paper can be criticised for introducing non-standard production functions that just serve to confuse the issue - they may fit the data better, but if the driver is just the use of useful work as a factor of production then they should keep it simple by explaining the issue purely in these terms. The authors claim that their results hold even if we just use a Cobb-Douglas production function.
The other interesting issue brought out by this paper is the divergence of their economic output as predicted from labour, capital and useful work, with actual economic output, post 1970. The authors postulate that this could be due to labour and capital using useful work more efficiently as prices increased in the 70's oil shock (this explanation is akin to Hassler, Krusell & Olovsson) or perhaps to to the rise of information technology. My only thoughts here were that it's interesting that this is also the point in time at which there is the divergence (at least in the US) of GDP per capita and median income, and between the GDP deflator and the CPI index (so that the economic statistics are "either overstating inflation (and hence understating income gains) or overstating economic growth").
This paper starts by noting that under normal assumptions, i.e. a constant returns to scale production function, changing factor endowments cannot explain the change in economic output over the 20th century. We need to postulate an additional factor: usually `technological progress'. This conclusion is qualitatively unaltered even if we expand the factors we consider from labour and capital to also include energy inputs.
However, if raw energy inputs are converted into `useful work' using estimated efficiency factors, then the change in labour, capital and useful work, at least over the 1900 - 1970 period, does seem to explain the change in economic output.
Is this an anodyne statement? Is every technological improvement basically just an improvement in the conversion of energy resources into useful work? Should we be surprised by this result? In particular, are we comfortable with idea that the productivity of labour has stayed constant and it's just that each unit of labour has more capital and joules to play with?
The paper can be criticised for introducing non-standard production functions that just serve to confuse the issue - they may fit the data better, but if the driver is just the use of useful work as a factor of production then they should keep it simple by explaining the issue purely in these terms. The authors claim that their results hold even if we just use a Cobb-Douglas production function.
The other interesting issue brought out by this paper is the divergence of their economic output as predicted from labour, capital and useful work, with actual economic output, post 1970. The authors postulate that this could be due to labour and capital using useful work more efficiently as prices increased in the 70's oil shock (this explanation is akin to Hassler, Krusell & Olovsson) or perhaps to to the rise of information technology. My only thoughts here were that it's interesting that this is also the point in time at which there is the divergence (at least in the US) of GDP per capita and median income, and between the GDP deflator and the CPI index (so that the economic statistics are "either overstating inflation (and hence understating income gains) or overstating economic growth").
Tuesday, 15 November 2011
Assorted Links
Some interesting stuff I've read recently on negative interest rates:
The negative unnatural rate of interest
the return of secular stagnation
a theory of the recession
a theory of the recession, ctd
Toy models of inequality, negative interest rates, revolutions, and trade deficits
negative real rates of return
and, from longer ago, on land values:
the stickiest price land and recessions
http://www.overcomingbias.com/2010/02/is-the-city-ularity-near.html
The negative unnatural rate of interest
the return of secular stagnation
a theory of the recession
a theory of the recession, ctd
Toy models of inequality, negative interest rates, revolutions, and trade deficits
negative real rates of return
and, from longer ago, on land values:
the stickiest price land and recessions
http://www.overcomingbias.com/2010/02/is-the-city-ularity-near.html
Wednesday, 26 October 2011
Who should pay for mal-investment?
I like this:
"under (successful) NGDP targeting, any depressions that occur will be inflationary depressions. ... If depressions occur even while the NGDP path is stabilized, then they will reflect some failure of supply or technology. Our aggregate investment choices will have proved misguided, or we will have encountered insuperable obstacles to carrying wealth forward in time. It is creditors, not debtors, whom we must hold accountable for patterns of aggregate investment. There always have been and always will be foolish or predatory borrowers willing to accept loans that they will not repay. We rely upon discriminating creditors to ensure that funds and resources will be placed in hands that will use them well. Creditors allocate capital by selecting the worthy from innumerable unworthy petitioners. An economic downturn reflects a failure of selection by creditors as a group. It is essential, if we want the high-quality real investment in good times, that creditors bear losses when they allocate funds poorly. When creditors in aggregate have misjudged, we must have some means of imposing losses without the logistical hell of endless bankruptcies. Our least disruptive means of doing so is via inflation."
"under (successful) NGDP targeting, any depressions that occur will be inflationary depressions. ... If depressions occur even while the NGDP path is stabilized, then they will reflect some failure of supply or technology. Our aggregate investment choices will have proved misguided, or we will have encountered insuperable obstacles to carrying wealth forward in time. It is creditors, not debtors, whom we must hold accountable for patterns of aggregate investment. There always have been and always will be foolish or predatory borrowers willing to accept loans that they will not repay. We rely upon discriminating creditors to ensure that funds and resources will be placed in hands that will use them well. Creditors allocate capital by selecting the worthy from innumerable unworthy petitioners. An economic downturn reflects a failure of selection by creditors as a group. It is essential, if we want the high-quality real investment in good times, that creditors bear losses when they allocate funds poorly. When creditors in aggregate have misjudged, we must have some means of imposing losses without the logistical hell of endless bankruptcies. Our least disruptive means of doing so is via inflation."
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