The Oil Drum

Economics is about marginal costs and income and the tendency of the invisible hand to drive prices in perfect markets to that point where supply and demand intersect, leading to consumer and producer surpluses for those able to operate more efficiently. (I am not sure if I managed to encapsulate the whole of Eco 101 in one sentence there but at least I tried!). Buried in here somewhere is the notion that the price of a commodity over time in inflation adjusted terms is constant.

At the time that Adam Smith was pontificating about his invisible hand, the earth and her resources were believed to be infinite for all practical purposes, even if it was known that they weren't. This is where classical economics started and it is where all modern economics, especially neo-classical economics and Marxism have their roots.

This idea of the "infinite" nature of resources is thus very deep rooted and it permeates the thinking that drives governments and the iron triangle. Here is a 2006 quote from Nick Minchen, Finance Minister, in the Australian Parliament: “the extent to which there is exploration for; and discovery of oil, is a function of price”. It was made at the time of last years run up in prices.

"Resource economics" is a sub-discipline of modern economics where the concept of sustainability has been given some thought. It is "where utility (consumption) is non-declining through time". For this to be possible it was proposed (Hartwick) that total capital, that is non-renewable natural capital (e.g. oil) and man-made capital (knowledge and physical assets), would be held constant. The idea being that "sufficient rent" would be saved from the extraction of the non-renewable resource to invest in the man-made capital so that the rule would be observed.

And thus, overall, the neo-classical price theory could be maintained - as the non-renewable resource petered out it would smoothly be replaced by a suitable substitute. Nick Minchen went on to say in the same statement that substitutes such as oil from shale’s would become available as prices dictate.

Minchen evidently lacks an understanding of the laws of thermodynamics; and he is by no means alone. Nevertheless a number of economists, among them Herman Daly, noted the impact of increasing levels of entropy frustrating efforts to replace "low entropy"/high value non-renewable resources. Although he said this 40 years ago, it is remarkable to witness the fiascos that are corn ethanol production in the US and syncrude production from tar in Canada today in the light of what he said.

My own humble view is that to an extent these economists were right - sufficient rent earned from the extraction of oil should have been invested in real alternatives: mass transit, localization, conservation and perhaps even substitutes. If we had husbanded this precious resource and not made endless plastic junk, built a huge infrastructure around cheap flights, or insisted on driving around the city in SUV's, we might have just about achieved this. Had governments done their job, they would have abolished income taxes in favour of energy taxes and forced investment in these solutions. Prices of energy (oil and substitutes) might indeed have remained constant over time.

But we didn't. And that is why we are here. We didn't because of the great 20th century divide between Marxism and capitalism (driven by neo-classical economics) and its very deep aversion to intervention from government of any kind. To this day, neo-classical economists abhor government intervention. This is perhaps why the Hirsch Report was buried so quickly. At its heart it advocated a switch to socialism: for the high energy/oil economy to be changed into a low energy/low oil economy, with a minimum of disruption, it would have to be centrally planned.

The discipline of economics does indeed have a lot to answer for. How is it that economics demonstrably understood the problem very clearly; and yet failed to bridge this divide? How did Nick Minchen and thousands of influential people like him get half trained?