Let’s Get Physical

It’s encouraging to see yet another indication of mainstream interest in giving nature its due in economic thought. My colleague Tom Prugh brought to my attention a recent story in the New York Times about the work of so-called “biophysical economists,” a small but intrepid band who, like their brethren in ecological economics (and in stark contrast to mainstream neoclassical economists) see economies as fundamentally rooted in and bounded by the limits of the natural world.   

Biophysical economists are particularly interested in the central role that energy plays in fueling economic activity. They focus on the energy return on investment (EROI): the ratio of energy inputs needed to produce energy output. In the United States in the 1930s, for example, it took the energy in 1 barrel of oil to extract 100 barrels of oil, an EROI of 100-to-1, according to the article. By 2006, this EROI had fallen to 19-to-1. 

Physical economy: What's the EROI?

Physical economy: What's the EROI?

The ever-shrinking petroleum EROI spells trouble for oil-based civilizations. Indeed, the history of civilizational advance is linked to the development of fuel sources with increasing EROIs, such as coal and oil. Part of the challenge for sustainable economies is that renewable energy sources, such as wind, solar, and biomass, have low or unknown EROIs. (For this reason, renewable energy advocates often also call for strong conservation and efficiency measures, to ease the pressure on renewables to provide energy at levels generated by energy-dense fossil fuels.)

Re-emphasis on the physical base of an economy is timely, given the role of finance (the non-physical economy) in causing the current recession. As a New York Times opinion piece noted earlier this year, unlike the real economy of material and energy, finance is built around a non-physical asset: debt. In excess, debt became a lever for generating prosperity out of thin air—until an external shock, the run-up in oil prices in early 2008, rattled debt holders, who suddenly preferred real (physical) assets like gold.

Sober economic management would prevent debt from being created faster than real, material wealth, according to the op-ed. To this end, ecological economist Herman Daly has proposed a 100-percent reserve requirement for banks, so that every dollar lent is backed by a dollar of saving, helping to curb the creation of excessive debt.  

The lesson? It’s vital to think in physical terms in any assessment of economic health.

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