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http://thearchdruidreport.blogspot.com/2011/12/future-cant-pay-its-bills.html

The Future Can't Pay Its Bills

I want to expand here on some of the points raised in last week’s post, because they deal with factors in our situation that operate well below the surface. One of the things that makes the predicament of industrial society so difficult for most people to notice, in fact, is that its effects are woven so deeply into the patterns of everyday life. Over the last decade, for example, crude oil prices have more than tripled; over the last decade, behind a froth of speculative booms and busts, the world’s industrial economies have lurched deeper into depression. Peak oil researchers have pointed out for years that the former trend would bring about the latter, but long after events proved them right, the connection still remains unnoticed by most people.

To be fair, the way most people and nearly all economists think about economics makes this sort of blindness to the obvious hard to avoid. It’s standard these days to treat the circulation of money—the tertiary economy, to use a term from my book The Wealth of Nature—as though it’s all that matters, and to insist that the cycles of nature and the production of goods and services (the primary and secondary economies) will inevitably do whatever we want them to do, so long as there’s enough money. This is why, for instance, you’ll hear economists insisting that the soaring price of oil is good for the economy; after all, all the money being spent to buy oil is getting spent in turn on other things, right?

What this ignores, of course, is the fact that the price of oil is going up, in large part, because petroleum is getting steadily more difficult to extract as we exhaust the easily accessible sources, and so the cost of oil production is going up while the amount of oil being produced is not. As a growing fraction of industrial civilization’s capacity to produce goods and services has to be diverted into oil extraction in order to keep the oil flowing, the amount of that capacity that can be used for anything else decreases accordingly. Notice, though, that this diversion isn’t an obvious thing; it happens one transaction at a time, throughout the economy, as laborers, raw materials, capital, and a thousand other things go into oil production instead of some other economic sector.

The place to begin making sense of the shape of the process under way, it seems to me, is the intriguing article by green economist Herman Daly, cited in last week’s post, about the way that the World Bank’s pursuit of global growth via the worship of economic orthodoxies ran headfirst into a shortage of "bankable projects"—in plain English, economic projects that would yield the ten per cent or so per year necessary to pay off the loan and also make a profit. The World Bank, as Daly recounts, tried to make up for the shortage by lowering its standards, and pouring money into projects that counted as bankable only in the same imaginary world where Pets.com stock and subprime mortgage-backed securities count as good investments.

The point I’d like to make here, though, is that a shortage of bankable projects has been a problem for some time now in regions not normally consigned to the Third World. The Rust Belt town where I live, Cumberland, Maryland, is one example. Until 1974 it was a significant industrial center, with two large breweries, a tire factory, a fabric mill, and several smaller concerns. 1974, though, was the year that the consequences of America’s first brush with peak oil hit home, and Cumberland was one of the targets. A combination of soaring raw material costs, slumping sales, and competition from overseas shuttered every factory in town, and none ever reopened. Cumberland, like the rest of the Rust Belt, suddenly had a shortage of bankable projects. The shortage wasn’t total—a handful of "big box" stores found construction loans during the retail-empire boom of the 1990s, for example—but rock-bottom real estate prices, favorable tax policies, low labor costs, and two colleges nearby to provide workforce training at state expense couldn’t lure factory jobs back into the region.

That same experience is being repeated now all over America, and for that matter across much of the industrial world. Capital shortage isn’t an issue—with two rounds of quantitative easing and a tacit agreement on the part of bank regulators not to raise awkward questions about the actual value of the paper assets owned by banks, there’s plenty of money available to lend—but loans aren’t being made, and the reason given by bank after bank is that next to nobody who wants to borrow money has a credible plan that will allow them to pay it back. That claim has been rejected with some heat by commentators, but I’ve come to suspect that it may be more accurate than not. That was exactly what happened to Cumberland, after all; in the changed economic environment after 1974, a factory built here wouldn’t have made enough money to pay back the loans that would have been needed to build it, and so the loans weren’t made. Increasingly, that seems to be true of the industrial world as a whole.

All this can be described, in the terms I used in The Wealth of Nature, as a widening mismatch between the tertiary economy of money and the secondary economy of goods and services—or, to put the matter even more simply, a rising tide of paper wealth chasing a falling tide of actual value. Still, I’ve come to think that there’s another way of looking at it—one that unfolds from the perspectives I’ve been discussing here over the last few weeks.

Let’s step away for a moment from the game of arbitrary tokens we call "money," and look at the economy from a thermodynamic perspective, as a system for producing goods and services by applying energy to an assortment of raw materials. Until the coming of the industrial revolution, the vast majority of the energy that went into human economic systems went from sunlight to crops to human and animal muscle, which produced and distributed goods and services. The industrial revolution transformed that equation adding torrents of cheap abundant fossil fuel energy to the annual income from photosynthesis. Only a small fraction of the labor force and other resources had to be diverted from food production to bring this flood of energy into the economic equation, and only a small fraction of fossil fuels had to be cycled back into the fossil fuel extraction process; the rest of the labor force, other resources, and all that additional energy from fossil fuels could be poured into the rest of the economy, producing goods and services in unparalleled amounts.

Physicist Ilya Prigogine has shown by way of intricate equations that the flow of energy through a system increases the complexity of the system. If any further evidence was needed to back up his claims, the history of the world’s industrial economies provides it. The three centuries that followed the development of the first functional steam engines saw economic complexity, measured by the creation of new job categories, soar to a level almost unimaginably greater than any previous civilization had achieved. The bonanza of wealth produced by adding fossil fuel energy to the sun’s annual contribution spread throughout the industrial economies, and the ways and means by which money sprayed outwards from the pockets of coal magnates and oil barons quickly became institutionalized.

Governments, businesses, and societies ballooned in complexity, creating niches for entire ecosystems of office fauna to do tasks the presidents and tycoons of the nineteenth century had accomplished with a tiny fraction of the personnel; workloads obeyed Parkinson’s Law—"work expands so as to fill the time available for its completion"—and everyone found that it was easier to add more staff to get a job done than to get the existing staff to do it themselves. The result, in most industrial societies, is an economy in which only a small fraction of the labor force actually has anything directly to do with the production of goods and services, while the rest are kept busy managing the sprawling social and economic machinery that has come into being to organize, finance, manage, staff, market, advertise, sell, analyze, tax, regulate, review, praise, and denounce the production of goods and services.

What seems to have been lost sight of, though, is that this immense superstructure all rests on the same foundation as any other economy, the use of energy to convert raw materials into goods and services. More to the point, it depends on a certain level of surplus that can be produced in this way, and that depends in turn on being able to add plenty of fossil fuel energy to the economic system without having to divert too large a fraction of the labor force, resource base, and energy supply into the extraction of fossil fuels. Some sense of the difference made by fossil fuels can be measured by comparing the economies of the industrial age to those of societies that, by any other standard, were near the upper end of human social complexity—Tokugawa Japan and Renaissance Italy are the ones that come to mind. Urban, literate, and highly cultured, each of these societies had the resources to support extraordinary artistic, literary, and intellectual creativity. Still, they did this with economies vastly simpler than anything you’ll find in a modern industrial society.

The division of the labor force among economic roles makes a good measure of the difference. In both societies, the largest economic sector, employing around fifty per cent of the adult population (nearly all adult women and most elderly people of both sexes), was the household economy; a good half of the total economic value produced in each society came out of the kitchen gardens, spindles, looms, and other economic facilities associated with households. Another thirty per cent or so of the population in each society, including most of the adult men, was engaged full time in farming and other forms of direct food production; maybe ten per cent of the adult population worked in the skilled trades; and the remaining ten per cent or so was divided between religious professionals, military professionals, artists and performers, aristocrats, and merchants who lived by buying and selling goods produced by others.

The limited range of categories available in those societies was not the result of inadequate cleverness. If some Italian despot or Tokugawa shogun had decided he needed a staff of human resource managers, corporate image consultants, strategic marketing specialists, and the rest of the occupational apparatus of modern business life, say, he would have been out of luck, and if he tried anyway, he would have been out of a job—the resources needed to train and employ some equivalent of modern office fauna would have had to be diverted from more immediate necessities such as training and employing an adequate force of condottieri or samurai, which was not exactly a viable strategy in those times. This is why Italian despots and Tokugawa shoguns got by with relatively small staffs of clerks, scribes, feudal subordinates, and maybe an astrologer; that’s what their economic systems could afford.

Equally, an aspiring craftsman or merchant faced real challenges in expanding his business beyond fairly sharp limits. In a few cases, a combination of luck, technical skill, and adequate transport allowed one region to take on a commanding role in some specific export market, profit considerably from that, and build up an impressive degree of infrastructure; the golden age of Greece was paid for by the profits from Greek wine and olive oil exports, for example, and the woolen trade brought similar benefits to late medieval Flanders. Far more often, though, local needs had to be supplied by local production, because the surplus energy that would have been needed to power long distance trade on a large scale simply didn’t exist, or couldn’t be spared from more pressing needs. Thus the institutional arrangements that governed economic life before the industrial age were as closely tailored to a world of relatively scarce energy, in which most people worked in the household or farming sectors of the economy, as today’s institutional arrangements are tailored to a world awash in cheap abundant energy.

That last point defines the crisis of our times, however, because we no longer live in a world awash in cheap abundant energy. We’ve still got a lot more energy than Renaissance Italy or Tokugawa Japan had, to be sure, but the per capita surplus is not what it once was, and a growing fraction of what we’ve got has had to be diverted to cover increases in direct and indirect energy costs of energy production. Meanwhile, the institutional arrangements are still firmly fixed in place, and they aren’t optional; try starting a business sometime without dealing with banks, real estate companies, licensing boards, tax authorities, et al., and you’ll quickly discover how non-optional these arrangements are.

The mismatch between the economy we’ve got and the economy we can afford has many implications, but one of the largest is precisely the issue I raised earlier in this post: across the industrial world, there are very few bankable projects to be found, even at a time when there are millions of people who need work, and who would happily buy products if they had the chance to earn the money to do so. Our economy is burdened with an unproductive superstructure it can no longer support. The globalization fad of the 1990s, which arbitraged the difference in wage costs between Third World sweatshops and industrial-world factories, was in effect an attempt to evade the resulting difficulties by throwing the industrial nations’ working classes under the bus, and it only worked for a decade or so; as so often happens in the declining years of a civilization, a short term fix was treated as a long term solution, and a brief remission of symptoms allowed the underlying crisis to worsen steadily.

Over the long run, the mismatch is a problem that will solve itself; once the unraveling of the industrial economy goes far enough, the superstructure will come apart, leaving a great many human resource managers, corporate image consultants, strategic marketing specialists, and the like with about as much chance of finding jobs in their fields as they would have had 17th-century Osaka or 14th-century Milan. In the short and middle term, though, the mismatch will almost certainly continue to show itself in exactly the same way that it’s been visible over the last few decades: more and more often, business ventures simply won’t be able to make enough money to cover startup costs or to stay in business.

Of course there will be exceptions. We are talking about a shift that will appear, as it has appeared so far, as a shifting of statistical averages, and the background of ordinary economic fluctuations will make it more than usually difficult to tease out the signal from the noise. Even in hard times, some ventures make fortunes; what makes hard times differ from boomtimes is that the fortunes are fewer, and the odds of making one of them come more and more to resemble the odds of walking away from a Vegas casino with a six-figure jackpot.

All this has two implications, it seems to me, that are of core importance for the shape of our future. The first is simply that those of my readers whose plans for the future depend on holding down a job may have a very hard row to hoe. The shift under way in the economy will more than likely squeeze the current model of economic life from both ends—as it becomes harder to find, keep, and earn a decent living at an ordinary job, businesses will continue to fold, debase their products, or both, and so it will also become harder to convert the income from an ordinary job back into goods and services worth having. One of the core themes I’ve been discussing here for some time now, the need to move at least one family member out of employment into the household economy, is in part a response to that situation; what you produce yourself for your own consumption doesn’t pay a share of the costs of the economic superstructure. Beyond that, the deterioration of the official economy is accompanied, as pretty much always happens, by the growth of alternative economic networks that allow goods and services to be exchanged outside normal channels; it may be a while before those networks become solid enough to support more than a few people, but taking part in exchanges through these networks even in their early stages may be worthwhile.

The second implication also relates to a core theme of this blog, though it’s on a larger scale. While other economic arrangements are certainly imaginable, the one we have right now is strictly limited in what it can accomplish by what can make a profit: to repeat Daly’s term, it has to be a bankable project, or by and large, it won’t get done. This may just turn out to be a far more dangerous limitation than anybody has yet realized. There are, after all, any number of plans for grand projects in response to the end of the age of cheap abundant energy; each of them would require the investment of a great deal of capital, labor, raw materials, and other resources; and under present arrangements, none of them can go forward unless someone can count on making a profit from making them happen. Under present arrangements, in turn, it’s likely that none of them will be profitable enough to get a construction loan or to cover their operating costs once they get built.

We’ve already seen a solid prefigure of this in the ethanol bubble of a few years ago, in which firms in corn states rushed to build ethanol plants. Even with government subsidies and a guaranteed market, a great many of those plants are now bankrupt and shuttered. It’s an open secret that many recent solar and wind energy projects make money only because of government subsidies. Grandiose plans to turn large swathes of Nevada into algal biodiesel farms or vast solar arrays are arguably even more likely to be subject to the same rule—and the subsidies in these latter cases would be ruinously expensive. Earlier posts here have discussed some of the other reasons why such projects will not be built; if the pattern I’ve sketched here is anything to go by, though, the future these projects imagine won’t arrive, because it won’t be able to pay its bills.