The Ecological Economics Critique

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Introduction

Ecological economists derive their view of the role of energy in economic growth from the biophysical foundations of the economy discussed above. While mainstream growth theory focuses on institutional limits to growth (e.g. Solow, 1978, 1993, 1997), ecological economists tend instead to focus on the material basis of the economy (e.g. Georgescu-Roegen, 1971; Costanza, 1980; Cleveland et al., 1984; Hall et al., 1986, 2001, 2003; Murphy and Hall, 2010). This view is shared by some geographers (e.g. Smil, 1994) and economic historians (e.g. Wrigley, 1988; Allen, 2009) who believe that energy plays a crucial role in economic growth, as well as being an important factor in explaining the industrial revolution. Ecological economic criticism of mainstream growth theory focuses on limits to substitution between capital and resources and limits to technological progress as ways of mitigating the scarcity of resources. If these two processes are limited then limited resources or the degradation of ecosystem services may restrict growth.

A prominent tradition in ecological economics is represented by biophysical models where energy is considered to be a primary factor of production and the only such primary factor. In this view, all value is derived from the action of energy that is directed by capital and labor. Payments to capital and labor represent a rent appropriated by the owners of these inputs but stemming from the productivity of energy (Costanza, 1980; Hall et al., 1986; Gever et al., 1986; Kaufmann, 1987). The flow of energy in the economy is the service of the reservoirs of fossil fuels and the sun, which represent a primary input in our terminology. In some biophysical economic models (e.g. Gever et al., 1986) geological constraints fix the rate of energy extraction so that the flow rather than the stock can be considered a primary input. On the other hand, capital and labor are treated as flows of capital consumption and labor services rather than as stocks, in other words, they are considered as intermediate inputs that are created and maintained by the primary input of energy and flows of matter. The value of the flows is computed in terms of the embodied energy use associated with them. Prices of commodities should then be determined by embodied energy cost (Hannon, 1973b) – a normative energy theory of value - or are actually correlated with energy cost (Costanza, 1980) - a positive energy theory of value (Common, 1995). This theory – like the Marxian paradigm - must then explain how labor, capital etc. end up receiving part of the surplus. Energy surplus must be appropriated by the owners of labor, capital, and land with the actual distribution of the surplus depending on the relative bargaining power of the different social classes and foreign suppliers of fuel (Kaufmann, 1987). If we assume that there are constant returns to scale, the production process of the economy as a whole can be represented by a Leontief input-output model with a single primary factor of production (Hannon, 1973a; Stern, 1999).

Cleveland et al. (1984), Hall et al. (1986), Hall et al. (2003), and Ayres and Warr (2005) among others argue that either energy, properly accounted for, accounts for most apparent productivity growth, or that technological change is real but innovations increase productivity by allowing the use of more energy. Therefore, increased energy use is the main or only cause of economic growth.

It is difficult to argue for this pure energy model as matter and organization or information are obviously important as discussed above. For example, the quality of resources such as oil reservoirs is critical in determining the energy required to extract and process fuels and other intermediate resource flows, which increases as the quality of resources declines over time with depletion. Changing resource quality results in changes in the embodied energy of the intermediate inputs indicating that human directed energy must be substituted for the services provided autonomously by nature. Odum’s emergy approach (see Brown and Herendeen, 1996; see also the framework developed by Costanza, 1980) also includes embodied solar and geological energy in indicators of total embodied energy. Thus changing resource quality is represented by changes in the embodied energy of the primary resources themselves. But this approach seems too reductionist. Other services provided by nature such as nutrient recycling, the provision of clean air and water, pollination, the climate system, and so on should also then be accounted for. These ecosystem services provide the conditions that make economic production—and life itself—possible.

A more sophisticated approach with a variety of different types of factors of production was already formulated by Georgescu-Roegen (1971). The neo-Ricardian models developed by Perrings (1987) and O'Connor (1993) also allow any number of inputs while complying with thermodynamic and mass-balance constraints.

Resource Quality and Economic Output
EROI – energy return on investment – is the ratio of useful energy produced by a method of energy supply for the amount of energy invested in extracting that energy. Lower quality energy sources have lower EROIs. Biomass usually produces less useful energy relative to the human energies expended in growing, harvesting, and processing the crop than and oilfield produces relative to the energy expended in discovering, extracting, and processing the oil. Larger, shallower oilfields typically have higher EROIs than smaller, deeper fields, and the EROI of an oilfield declines over time as pressure falls due to the extraction of oil.

Biophysical economists argue that the more energy that is required to extract energy the less energy is available for other uses and the poorer an economy will be. In pre-industrial societies most workers were engaged in growing food and collecting fuel. Only a small fraction of society could use the small energy surplus generated to produce other products and services. In other words, as energy needs to be used with other inputs, most of societies’ factors of production were directed to energy extraction. In this view, the increase in EROI allowed by the switch from biomass to fossil fuels enabled the industrial revolution and the period of modern economic growth that followed it (Hall et al., 1986).

Declining EROI would threaten not just growth but also the level of output of the economy and, therefore, sustainability. Murphy and Hall (2010) document EROI for many energy sources, arguing that it is declining over time. Wind and direct solar energy have more favorable EROIs than biomass fuels but worse than most fossil fuels. However, unlike fossil fuels, the EROI of these energy sources tends to improve over time with innovation (Kubiszewski et al., 2010). But current usage is very small and Murphy and Hall argue that there is no prospect of them replacing a large part of fossil fuel usage in the near future.

Declining EROI could be mitigated by substituting other inputs for energy or by improving the efficiency with which energy is used. However, biophysical economics argues that both these processes have limits.


Limits to Substitution
There is more than one type of substitution between inputs and, therefore, there is more than one reason why substitution may be limited. There can be substitution within a category of similar production inputs – for example between different fuels - and between different categories of inputs – for example between energy and machines. There is also a distinction to be made between substitution at the micro level - for example in a single engineering process or in a single firm – and at the macro level – in the economy as a whole. Finally, some types of substitution that are possible in a single country are not possible globally.

Solow (1997) argues that within category substitution, and in particular the substitution of renewable for nonrenewable resources, is most important and seems to assume that new substitutes will always be found. It is possible that the elasticity of substitution for within category types of substitution exceeds unity. The long run pattern of energy use in industrial economies has been dominated by the substitutions from wood and waterpower to coal, oil, natural gas and primary electricity (Hall et al., 1986; Smil, 1991). In large part the industrial revolution was enabled by the use of fossil fuels that freed economic activity from reliance on low power and variable but renewable solar energy. When fossil fuels are economically exhausted the next stage of energy development may see a return to solar energy, albeit captured in a more sophisticated way, rather than a move to a new substitute. Meta-analysis of existing studies of interfuel substitution (Stern, 2009) suggests that the long-run elasticity of substitution between coal and natural gas is greater than unity and that that between oil and electricity is less than unity with the other interfuel elasticities insignificantly different from unity. But the values of the elasticities are very sensitive to the estimator used and more research is needed.

Ecological economists emphasize the importance of limits to the between category type of substitution, and in particular, the substitution of manufactured capital for resources including energy (Costanza and Daly, 1992). A number of arguments for limited substitutability have been put forward, with the main ones that are relevant to the energy case described below. The terms “substitute” and “complement” have been used very loosely in this literature as elsewhere in economics (Stern, 2007). Instead, we can classify inputs as good or poor substitutes as measured by the Hicks or Direct Elasticity of Substitution. This elasticity reflects movement along an isoquant of the production function holding all other inputs constant. It can take values from zero (Leontief function) to infinity (linear production). Good and poor substitutes have elasticities of substitution of greater than and less than unity, respectively. A meta-analysis of the existing empirical literature finds that the elasticity of substitution between capital and energy is less than unity (Koetse et al., 2008).

Thermodynamic limits to substitution. Thermodynamic limits to substitution are easily identified for individual processes by an energy-materials analysis that defines the fundamental limitations of transforming materials into different thermodynamic states and on the use of energy to achieve that transformation (Ruth, 1993; Islam, 1985). It might be argued that standard production functions can account for mass balance and thermodynamic constraints if the elasticity of substitution between capital and resources is less than or equal to unity so that resources are essential. The Cobb-Douglas production function has the essentiality condition. Given positive non-energy inputs, output is only zero when the energy input is zero, and strictly positive otherwise. This at least accounts for the fact that some amount of energy and materials are required to produce goods and services. But when the elasticity of substitution is unity this “essential” amount can be infinitesimal if sufficient manufactured capital is applied. Therefore, this condition does not satisfy thermodynamic considerations throughout the domain of the function. Thermodynamic limits can be approximated by a production function with an elasticity of substitution significantly below unity.

Material cause and efficient cause. Georgescu-Roegen’s (1976) fund-flow model describes production as a transformation process in which a flow of materials, energy, and information – the material cause - is transformed by two agents of transformation, human labor and manufactured capital – the efficient cause that effect the transformation. Thus, Daly (1991) argues that adding to the stock of pulp mills (efficient cause) does not produce an increase in pulp unless there also is the wood fiber (material cause) to feed them. From this perspective, capital should be a poor substitute for energy and other resources.

Mainstream economists think about this question differently. First, they argue that though additional capital cannot conjure wood fibers out of thin air, more capital and “smarter” capital can be used with each amount of wood fibers to produce more sophisticated and valuable products, and that this is the relevant substitution between capital and resources. Thermodynamic limits only apply to production of specific physical products. There is then no limit to the potential value of product created through sophisticated manipulation using larger amounts of capital (van den Bergh, 1999).


Physical interdependence and macroeconomic and global limits to substitution. The construction, operation, and maintenance of tools, machines, and factories require a flow of materials and energy. Similarly, the humans that direct manufactured capital consume energy and materials in the form of food, water, and other subsistence needs. Thus, producing more of the “substitute” for energy - manufactured capital - requires more of the thing that it is supposed to substitute for. This again limits potential substitutability.

Ecological economists argue that production functions used in growth models do not account for this interdependence, and thus assume a degree of substitutability that does not exist (Georgescu-Roegen, 1979; Cleveland et al., 1984; Ayres and Nair, 1984; Kaufmann, 1992; Daly, 1997, Stern, 1997). But we must distinguish between micro-and macro-applications of production functions. Substitution seems to be fundamentally more constrained at the macro-level of analysis than at the micro-level (Stern, 1997). For example, home insulation directly substitutes for heating fuel within the household sector. But that insulation requires fuel to manufacture, so for the economy as a whole the net substitution of insulation for fuel is less than that indicated by an analysis of the household sector in isolation from the rest of the economy. Put another way, the aggregate of potential energy savings at the macroeconomic level is less than the sum of the savings one would calculate by adding the savings from sectoral-level analyses that do not account for the indirect costs.

















In the figure, the curve E = f(M) is a neoclassical isoquant for a constant level of output, where E is energy, and M materials, including the material embodied in capital. The indirect energy costs of materials are represented by g(M). For simplicity, the diagram unrealistically assumes that no materials are required in the extraction or capture of energy. Addition of direct and indirect energy costs results in the "net" isoquant E = h(M). Generalizing for material costs to energy extraction suggests that there are eventually decreasing returns to all factors at the macro level and therefore the socially efficient region of the aggregate production function does not include areas with extreme factor ratios. This idea may be supported by a meta-analysis of the capital-energy elasticity of substitution that shows a lower elasticity for more aggregated sectors than for less aggregated sectors (Koetse et al., 2008).

Additionally, at the global level, countries such as Kuwait, Nauru, or Norway can deplete their natural resources and invest in manufactured capital offshore through the financial markets. But this route to substituting manufactured capital for natural capital is clearly not possible for the world as a whole.

Limits to Technological Change
But, as discussed above, if substitution possibilities are limited, sustainability may be possible if technological change is resource augmenting and unlimited in scope. This argument would be more convincing if technological change were really something different from substitution. This is not really the case. The neoclassical approach assumes that an infinite number of efficient techniques coexist at any one point in time. Substitution occurs among these techniques. Changes in technology occur when new more efficient techniques are developed. However, these new techniques really represent the substitution of knowledge for the other factors of production. The knowledge is embodied in improved capital goods and more skilled workers and managers, all of which require energy, materials, and ecosystem services to produce and maintain. Thus, however sophisticated the workers and machinery become, there are still thermodynamic restrictions on the extent to which energy and material flows can be reduced.

The difference between knowledge and other forms of capital is that knowledge is non-rival in use – in other words the same idea can be used simultaneously in different locations and production processes without any reduction in the productivity of the knowledge in the different locations and processes. This means that there are constant returns to the application of knowledge in production while other inputs experience diminishing returns. But knowledge must be used in conjunction with the other inputs such as energy. The productivity of knowledge is still determined by the available quantities of those inputs.

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