Ecological Economics and the Crisis

https://openeconomicsnd.wordpress.com/2009/04/14/ecological-economics-and-the-crisis/

Ecological Economics and the Crisis

April 14, 2009 by Nick Krafft

Saturday’s NYT Op-Ed page (h/t Mark Thoma) brought an interesting articleabout an intellectual I had never heard of, Frederick Soddy.

A 1921 Nobel laureate in chemistry for his work on radioactive decay, he foresaw the energy potential of atomic fission as early as 1909. But his disquiet about that power’s potential wartime use, combined with his revulsion at his discipline’s complicity in the mass deaths of World War I, led him to set aside chemistry for the study of political economy — the world into which scientific progress introduces its gifts. In four books written from 1921 to 1934, Soddy carried on a quixotic campaign for a radical restructuring of global monetary relationships. He was roundly dismissed as a crank.

He offered a perspective on economics rooted in physics — the laws of thermodynamics, in particular. An economy is often likened to a machine, though few economists follow the parallel to its logical conclusion: like any machine the economy must draw energy from outside itself…

Soddy criticized the prevailing belief of the economy as a perpetual motion machine, capable of generating infinite wealth — a criticism echoed by his intellectual heirs in the now emergent field of ecological economics. A more apt analogy, said Nicholas Georgescu-Roegen (a Romanian-born economist whose work in the 1970s began to define this new approach), is to model the economy as a living system. Like all life, it draws from its environment valuable (or “low entropy”) matter and energy — for animate life, food; for an economy, energy, ores, the raw materials provided by plants and animals. And like all life, an economy emits a high-entropy wake — it spews degraded matter and energy…

The law of entropy commands a one-way flow downward from more to less useful forms. An animal can’t live perpetually on its own excreta…Thus, Georgescu-Roegen, paraphrasing the economist Alfred Marshall, said: “Biology, not mechanics, is our Mecca.”…

Following Soddy, Georgescu-Roegen and other ecological economists argue that wealth is real and physical…Debt, for its part, is a claim on the economy’s ability to generate wealth in the future. “The ruling passion of the age,” Soddy said, “is to convert wealth into debt”…

Problems arise when wealth and debt are not kept in proper relation. The amount of wealth that an economy can create is limited by the amount of low-entropy energy that it can sustainably suck from its environment — and by the amount of high-entropy effluent from an economy that the environment can sustainably absorb. Debt, being imaginary, has no such natural limit. It can grow infinitely, compounding at any rate we decide…

an economy with overgrown claims on future wealth will experience regular crises of debt repudiation — stock market crashes, bankruptcies and foreclosures…Each and every one of the crises that has beset the American economy in recent years has been, at heart, a crisis of debt repudiation. And we are unlikely to avoid more of them until we stop allowing claims on income to grow faster than income.

Soddy would not have been surprised at our current state of affairs. The problem isn’t simply greed, isn’t simply ignorance, isn’t a failure of regulatory diligence, but a systemic flaw in how our economy finances itself…

Soddy’s fifth proposal, the only one that remains outside the bounds of conventional wisdom, was to stop banks from creating money (and debt) out of nothing. Banks do this by lending out most of their depositors’ money at interest — making loans that the borrower soon puts in a demand deposit (checking) account, where it will soon be lent out again to create more debt and demand deposits, and so on, almost ad infinitum.

One way to stop this cycle, suggests Herman Daly, an ecological economist, would be to gradually institute a 100-percent reserve requirement on demand deposits. This would begin to shrink what Professor Daly calls “the enormous pyramid of debt that is precariously balanced atop the real economy, threatening to crash.”…

In such a system, every increase in spending by borrowers would have to be matched by an act of saving or abstinence on the part of a depositor. This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth…

If such a major structural renovation of our economy sounds hopelessly unrealistic, consider that so too did the abolition of the gold standard and the introduction of floating exchange rates back in the 1920s. If the laws of thermodynamics are sturdy, and if Soddy’s analysis of their relevance to economic life is correct, we’d better expand the realm of what we think is realistic.

Until I read this article, I had not begun to think about the value of an ecological perspective on the crises of capitalism. However, this view of debt and wealth offers a nice metaphor for these crises, and also an intriguing policy prescription, which essentially would limit leveraging. The weakness of ecological economics is that it offers little in the way of explanations for why the debt buildups occur (not that it needs to, since Marxian economics has this covered). On the other hand, a strength is that when people argue that economics should be more scientific, you can nod yes, and remind them that thermodynamics, and not just mechanics, is an important part of physics.

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As it happens (and as the article touches on), thermodynamics also offers an excellent way of thinking about the environment. For those interested, this chapter from Unearthed, a book in progress byNotre Dame’s Kenneth Sayre, offers an excellent summary of entropy and the ecosystem.