Sunday, April 18, 2010

Energy as a Factor of Production

This section is almost unchanged from the 2004 version. I haven't seen anything recent that adds much to what's here. Have you?

Energy as a Factor of Production
The potentially critical role of energy in economic production and growth is dictated by basic physical principles. The laws of thermodynamics and the conservation of matter describe the immutable constraints within which the economic system must operate (Ayres and Kneese, 1969; Boulding, 1966). The first law of thermodynamics (the conservation law) implies the mass-balance principle (Ayres and Kneese, 1969). In order to obtain a given material output, greater or equal quantities of matter must be used as inputs with the residual a pollutant or waste product. Therefore, there are minimal material input requirements for any production process producing material outputs. The second law of thermodynamics (the efficiency law) implies that a minimum quantity of energy is required to carry out the transformation of matter. Carrying out transformations in finite time requires more energy than these minima (Baumgärtner, 2004). All production involves the transformation or movement of matter in some way. Some matter must be moved or transformed though particular elements and chemicals may be substitutable. Therefore, there must be limits to the substitution of other factors of production for energy. All economic processes must, therefore, require energy, so that energy is always an essential factor of production (Stern, 1997). In practice, recycling cannot be 100% complete due to the enormous energy costs of collecting very diffuse wastes and, therefore, pollution reduction also becomes increasingly costly. As long as sufficient energy is available this does not as proposed by Georgescu-Roegen (1971) pose an ultimate limit to economic production (Biancardi, et al., 1993). But it does imply environmental disruption, and as resource concentration and quality fall from their historically high levels increasing energy costs in obtaining resources (Hall et al., 1986).

Two key concepts in the economics of production that are often confused in the debate on the role of energy in the economy are reproducibility and the distinction between primary and intermediate inputs. Some inputs to production are non-reproducible, while others can be manufactured, at a cost, within the economic production system and are said to be reproducible. Capital, labor, and in the longer term even natural resources, are reproducible factors of production, while energy and matter are nonreproducible factors of production. Energy vectors - fuels – and raw materials like minerals are in theory reproducible factors (Stern, 1999) though with the exception of agriculture and forestry they are usually harvested from nature and represent the accumulated work of the planet’s biogeochemical cycles, which in turn are powered by energy from the Sun and the Earth’s internal heat.

As neither energy nor matter are reproducible they must be captured from the environment with implied environmental disruption. This is especially relevant for energy as due to the entropy law, exergy – useful energy – cannot be recycled or reproduced. While some forms of energy capture are possibly more hazardous to human health or damaging to environmental quality, all methods – nuclear, fossil fuels, hydropower, windpower, biomass etc. - are environmentally disruptive. Solar energy is very diffuse compared to the concentrated stocks of fossil fuels and plants and animals are very inefficient converters of that energy into energy and work useful to people. This is why the shift to fossil fuels through the industrial revolution released the constraints on production and growth that existed previously (Wrigley, 2003).

Some aspects of organized matter - that is information - might also be considered to be non-reproducible inputs. Several analysts (e.g. Spreng, 1993; Chen, 1994; Stern, 1994; Ruth, 1995) argue that information is a fundamentally nonreproducible factor of production in the same way as energy, and that economics must pay as much consideration to information and its accumulation as knowledge as it pays to energy. Energy is necessary to extract information from the environment while active use of energy cannot be made without information and possibly accumulated knowledge. Obviously, energy can provide uncontrolled heating, lighting etc. without any activity on the part of economic agents. But even non-intelligent organisms need to use information to make controlled use of energy. For example, when plants use some sunlight for photosynthesis rather than just heating and lighting their leaves they are using the information in their genetic code to produce chlorophyll, construct chloroplasts, and generate sugar. Unlike energy, information and knowledge cannot be easily quantified. However, the fact that they must be incorporated into machines, workers, and materials in order to be made useful provides a biophysical justification for treating capital, labor etc. as factors of production. Though capital and labor are easier to measure than information and knowledge, their measurement is, still, very imperfect compared to that of energy (Stern, 1999).

Primary factors of production are inputs that exist at the beginning of the period under consideration and are not directly used up in production (though they can be degraded or accumulated from period to period), while intermediate inputs are those created during the production period under consideration and are used up entirely in production. Mainstream economists usually think of capital, labor, and land as the primary factors of production, while goods such fuels and materials are intermediate inputs. The prices paid for all the different inputs are seen as eventually being payments to the owners of the primary inputs for the services provided directly or embodied in the produced intermediate inputs (Stern, 1999).

This approach has led to a focus in mainstream growth theory on the primary inputs, and in particular, capital and labor. Once the centerpiece of the classical economic model, land, meant here to include all natural resource inputs to production, gradually diminished in importance in economic theory as its value share of GDP fell steadily in the 20th century (e.g. Schultz, 1951) and today is usually subsumed as a subcategory of capital. Energy and other resources are attributed a lesser and somewhat indirect role in the mainstream theory of production and growth. The primary energy inputs are stock resources such as oil deposits while the flow of energy available to the economy in any period is endogenous, though restricted by biophysical constraints such as the pressure in oil reservoirs and economic constraints such as the amount of installed extraction, refining, and generating capacity, and the possible speeds and efficiencies with which these processes can proceed (Stern, 1999). But these are not given an explicit role in the standard macroeconomic growth theories that focus on labor and capital. Therefore, understanding the role of energy in the mainstream theory of growth is not so straightforward and the role of energy as a driver of economic growth and production is downplayed.

Ayres, R.U., and A.V. Kneese (1969). “Production, consumption and externalities.” American Economic Review 59: 282-97.
Baumgärtner, S. (2004) Thermodynamic Models, In: J. Proops and P. Safonov (eds), Modelling in Ecological Economics, Cheltenham: Edward Elgar, 102–129.
Bianciardi, C., E. Tiezzi, and S. Ulgiati (1993). “Complete recycling of matter, in the frameworks of physics, biology, and ecological economics.” Ecological Economics 8: 1-6.
Boulding K. (1966) The Economics of the Coming Spaceship Earth, in H. Jarett (ed.), Environmental Quality in a Growing Economy, Johns Hopkins University Press, Baltimore MD.
Chen, X. (1994). “Substitution of information for energy: conceptual background, realities and limits.” Energy Policy 22: 15-28.
Georgescu-Roegen N. (1971) The Entropy Law and the Economic Process, Harvard University Press, Cambridge MA.
Hall, C. A. S., C. J. Cleveland, and R. K. Kaufmann (1986). Energy and Resource Quality: The Ecology of the Economic Process. New York: Wiley Interscience.
Ruth, M. (1995). “Information, order and knowledge in economic and ecological systems: implications for material and energy use.” Ecological Economics 13: 99-114.
Schultz, T. W. (1951) “A framework for land economics – the long view.” Journal of Farm Economics 33: 204-215.
Spreng, D. (1993). “Possibilities for substitution between energy, time and information.” Energy Policy, 21: 13-23.
Stern, D. I. (1994). Natural Resources as Factors of Production: Three Empirical Studies. Ph.D. Dissertation, Department of Geography, Boston University, Boston MA.
Stern, D. I. (1997). “Limits to substitution and irreversibility in production and consumption: a neoclassical interpretation of ecological economics.” Ecological Economics, 21: 197-215.
Stern, D. I. (1999). “Is energy cost an accurate indicator of natural resource quality?” Ecological Economics 31: 381-394.
Wrigley, E. A. (2003). The First Industrial Revolution, Paper presented at the Colloquium on Energy, Economic Growth and Pollution, King’s College, Cambridge 24th-26th October.

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