Paradigm-challenged economists: Bernanke and the Solow model

Perhaps the best example of the paradigm challenge affecting most of today's economists that I commented on in http://peaktimeviews.blogspot.com/2007/12/are-economists-paradigm-challenged.html is none other than Professor Ben Bernanke: his whole mindset seems to have been shaped by the study of the Great Depression and how to avoid a relapse into it. Wake up, Professor, the world is in a completely different situation now! Notably, 2007 for the US is timewise the exact opposite point to 1933 with respect to the US Hubbert's Peak: 1933 + 37 = 1970; 1970 + 37 = 2007. But what matters is that the world is now either past or about to reach its GLOBAL Hubbert's Peak. Therefore all the body of Keynesian and more generally demand-side economics is no longer valid: now the limits to growth are set by physical constraints, not by lack of demand.

But there seems to be yet a further theoretical hindrance to Bernanke's adaptation to the new resource-constrained world: the Solow model of economic growth. Besides authoring six papers on the Great Depression, more recently (2001) he coauthored a paper "Is Growth Exogenous? Taking Mankiw, Romer and Weil Seriously" at http://www.nber.org/papers/w8365 . If you open it and search for "energy" or "resource", you will not find a single occurrence of any ot those words. Not one! Pathetic as it is, it just reflects the flaw in the Solow model itself: economic output Y = F(A,K,L) with A aka TFP and loosely defined as "technological progress" depends only of time and accounts for over 80 % of the per capita growth in output. This model suffers from two critical deficiencies:

First, it does not actually explain economic growth. A(t) remains to be explained. It remains "a measure of our ignorance", as shown in Lipsey (2001) "What does total factor productivity measure?" at http://www.csls.ca/ipm/1/lipsey-e.pdf .

Secondly, though perhaps more important, it decouples growth from physical resources consumption.

However, a look at what happened in the real world when economic growth started in earnest (the Industrial Revolution) shows that it was not just any technological progress what enabled it. It was specifically that technological progress which enabled the conversion of raw energy inputs (usually thermal energy from the combustion of fossil fuels) into useful work:

- the steam engine around 1780 (from coal) and its applications,
- the internal combustion engine around 1880 (from oil) and its applications,
- the hydroelectrical turbine around 1880 (from waterfalls)
- and the electrical technology which greatly increased the transportability and versatility of useful work generated from any energy input.

But it does not take a genius to see that all of these technologies will result in increasing economic output if, and only if, there are increasing quantities of raw energy inputs (once conversion efficiency has reached its ceiling).

Therefore, a realistic model of production is that in which Y = F(K,L,U) where U = f x R, and
U = useful work,
R = raw energy input aka exergy, and
f = efficiency with which energy input is converted into useful work.

This model has been developed by Robert Ayres and Benjamin Warr ( www.insead.edu ), building upon earlier work of Reiner Kummel. (Interestingly, Ayres and Kummel hold PhD degrees in Physics.) They successfully tested it first against US data and then against other countries, as shown in their latest presentation athttp://ida.dk/NR/rdonlyres/11027443-C01D-45E2-9D4E-B5A368A692C8/0/SGTCopenhagen22May2006Warr.pdf (*)

So, knowing that Professor Bernanke is an Orthodox Jew, I'd say to him: Keynes is not Moses, Keynesian economics is not the Torah, and Solow is not Isaiah. Get rid of them!

(*) For anyone interested in this topic, a good source of information is David Strahan's book "The Last Oil Shock" http://www.lastoilshock.com/ . Follow the links to a couple of comments on this book's coverage of the topic:

1. http://www.paulchefurka.ca/Economics.html (Too long to paste. BTW, I'm not Paul Chefurka.)

2. http://sandersresearch.com/index.php?option=com_content&task=view&id=1176&Itemid=105

"It is at this juncture that The Last Oil Shock is particularly worth reading, because it sets out why oil is really that important in chapter five, "Last Oil Shock, First Principles". The nub of the issue is actually quite easy to comprehend in an intuitive way: economic “growth” is possible mostly because of energy, and in modern times the exploitation of first coal, then oil and gas, is what has made possible the exponential growth of the last two hundred years. It is quite simple, really. These carboniferous deposits represent the stored energy of ancient sunlight that is being exploited in a go by modern man. Once gone, they are gone. The reason they are so important is because they are energy dense, meaning that their molecules contain a lot of stored energy and they are relatively easy to transport. Nothing else, not nuclear power, solar or wind generation, hydro, nor biomass has these characteristics.

In a more formal manner this can be demonstrated mathematically, as scientists such as Walter Kümmel, Charles Hall and Robert Ayres have done. Don’t worry if your maths are weak; Strahan walks you through the Solow Residual, that fraction of economic growth unexplained (until Kümmel, Hall, and Ayres came along) by the orthodox inputs of capital and labour. The idea that most growth is a function of ever-increasing amounts of energy being used (Kümmel and Hall) that is being more efficiently employed (Ayres) is revolutionary enough, if simple. The fact that the fraction of growth it is responsible for is many multiples of that added by capital and labour is an embarrassment for the exponents of mainstream so-called neoclassical economics. Indeed, this is one of the more exciting prospects raised by peaking world oil and gas production: to tear down the temple that Marshall, Keynes, Friedman and others have built and replace it with an approach to understanding political economy that is intellectually honest, consistent with the basic physical principles of the universe we live in, pragmatic, and accessible to all."