Educators’ dilemma: is neoclassical economics consistent with the laws of physics?

As educators, our most important task is to help prepare our students to lead successful professional and personal lives, for the next 40+ years, until 2060 and well beyond. While much is unknown on this time scale, we now do understand the big picture, including fundamental human needs, as well as the material basis for satisfying them, especially around biodiversity and energy – the previous blog “Reflections on 2018: complexity, messiness, progress” provides a few illustrations.

So, while we cannot provide recipes valid for half a century, we certainly can help our students develop a way of thinking, even a worldview, which will prepare them for the challenges they will face.

This means first and foremost understanding human society and the economy in “real”, biophysical terms, including the underlying energy and material flows.

We could start with biophysical economics, a school of economics based on biological and physical resources, with a strong focus on energy, especially around food production, new energy sourcing, and the concept of EROI (energy return on (energy) invested). Biophysical economics has a long history, starting in the 1920s with Frederick Soddy (building on 19th-century insights, especially the laws of thermodynamics), with major contributions by Nicholas Georgescu-Roegen in the 1970s, and more recently by Charles A. S. Hall, Cutler Cleveland, and Robert Costanza. The Encyclopedia of Earth provides an excellent overview.

So far, this work has remained outside of mainstream economics. There are many reasons, including a much higher complexity of looking at underlying material and energy flows instead of money, and the fact that most leading practitioners, including all listed above, are not economists. It requires a fundamentally cross-discipline approach. At the same time, this is a big opportunity for teachers of other disciplines beyond economics to help expand learners’ perspective. I sincerely hope this gives rise to many fundamental reflections.

Biophysical economics is closely related to ecological economics, but differs in its focus on energy and entropy, compared to the latter’s focus on ecosystem services. Both are forms of strong sustainability, as opposed to environmental economics and similar approaches, which complement neoclassical economics with pricing externalities, but regard all forms of capital as interchangeable (for example, human misery or polluted water is OK, as long as sufficient economic value is created). Biophysical economics not at all related to econophysics, which applies methods (originally developed in physics) around stochastic processes and nonlinear dynamics to classical economics – to simplify market economics worldview, physics tools.

Notwithstanding its sophisticated mathematical toolbox, neoclassical economics considers itself (and is) a social science, focusing on markets and human behavior, mainly of consumers and managers. In the classical view, scarcity leads to higher prices, spurring technological innovation and substitution, allowing the economy to continue growing (forever).

Let me illustrate this disconnect with a few examples:

  • Absurd energy-related decisions: producing bioethanol (a biofuel) requires oil, and for every 100 joules (J) of oil, around 80 J of bioethanol are produced – a net energy loss of 20%, in addition to pollution, biodiversity loss, human labor, etc. In real terms, this makes absolutely no sense; with subsidies, in our distorted financial system, it might be profitable.
  • New energy sources: our growth society requires constant discovery of new energy with an EROI (energy return on invested) >11 (Fizaine and Court, 2016, “Energy expenditure, economic growth, and the minimum EROI of society”). Historically, oil had an EROI over 100, current oil sources are around 17 and falling; solar panels typically have an EROI of 4-8. There are currently no known new energy sources, broadly scalable in the coming decades, with the required EROI to maintain our growth economy.

revisiting the limits to growthSource: Hall and Day, 2009, “Revisiting the Limits to Growth After Peak Oil”

  • Decoupling economic growth from energy use is unfortunately not happening. In fact, due to the rebound effect, energy efficiency often leads to an absolute increase in energy demand. For example, our consumption of energy for lighting has increased about 100’000 times over 300 years, or about 10’000 times per capita, in spite of an extraordinary increase in efficiency. The consumption of light itself increased a billion times.

All models are oversimplified and wrong; some are however useful. Unfortunately, the neoclassical economics model has outlived its usefulness. Consequently, many economists, managers, and political leaders make dangerous decisions not understanding the physical limits, or at least the practical limits to substitutability, scaling and deployment. The reason I believe the biophysical economics model will be much more useful is that it starts with the most fundamental constraints of all life: energy and entropy.

To answer the question in the title: with the notable exception of limits to material and energy consumption growth, neoclassical economics mostly stays within the laws of physics (without necessarily paying much attention to them), sadly ignoring the biosphere it depends on. Just as bad, it completely ignores human well-being beyond the idealized, rational, by now discredited “homo oeconomicus”. As such, it is no longer serving the society it is part of.

The way forward: while we know what we need to do, we don’t quite know how to get there in the relatively short time available, in a world of soon-to-be severely constrained energy and degrading-but-still-functioning ecosystem services.

As educators, we’ll succeed if we equip our students to experiment as (social) entrepreneurs and find effective solutions to human and environmental issues. Just as importantly, our students should feel empowered to shape the reality they live in, take proactive steps towards changing the rules of the game, vote and engage in politics, and serve as role models in their communities. Some of their projects could become the seeds of future human prosperity. Helping learners move beyond neoclassical economics will be a necessary first step. A deep awareness of the biophysical reality might be a good place to start. This is our challenge for all teachers and learners, in every discipline.

Sascha_NICK Author: Sascha Nick, BSL Professor

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