Some crystal ball gazing

If my last blog, about the peak of global oil production and a sustained fall in global production, contained an ounce of truth, some interesting trends should occur in the next year or two. First, we should see the price of oil rise again from its current price of around $60 a barrel. Second, we should see an increase in the inflation rate on a relatively global scale. (Note that in the UK, inflation is currently at 4.4%. With the base interest rate at 4.5%, the real interest rate is now effectively zero). Third, we will see a sustained decline in global output. Taken together, a recipe for stagflation. (I also predict continued volatility on financial markets as demand and supply expectations feed back on each other).

Interestingly, simple macro-economic principles can explain how this will occur if interpreted correctly. One simply has to remember that supply and demand are not independent from each other. Each drives the other in a dynamic feedback cycle. Let me try to explain.

If we use the simple aggregate supply (AS) and aggregate demand (AD) curves, we can describe what I believe has been occurring in the past two years, and will occur for the next few. Looking at the figure below, we see the intersection of AD and AS at price level P1. Taking my peak oil explanation of the current financial turmoil, we should first see slight shift to the right of the AD. This growth in demand expectations is what was been driving up the share market and commodity prices in 2005-2007. This was not accompanied by a large increase in supply as physical limits (peak oil) were being met (hence the steep AS curve). Therefore we see a rise in the price level (inflation), and we see why the Australian reserve bank lifted interest rates in that period.


In time, the realisation that these demand expectations would go unfulfilled, due to supply (output) failing to increase, demand expectations dropped, shifting the demand curve dramatically to the left. This had a huge impact on commodity prices, with large drops seen in metals prices, and the oil price, and shares prices in general.


But this is not the end of the story. If I am correct, and supply will begin a slow decline, demand expectations will begin to factor in this decline. Both AS and AD will creep leftwards. To arrest this de-growth or un-growth, monetary policy will be loosened, with the intention of stimulating investment and a growth in supply. But alas, this will not occur due to the physical limits of oil production having been reached.


Importantly, using the AD and AS graph, when this leftward creep happens, the price level remains the same. How does inflation occur in this circumstance? It occurs because the money supply does not contract as easily as output does. Additionally, the likely reaction of governments and central banks will be to stimulate demand with fiscal policy, (think of Kevin Rudd’s one-off payments in Dec), and stimulate investment in supply with loose monetary policy (lowering interest rates – remember the real interest rate is close to zero in the UK, and I would suggest that this may be the case globally very soon).

The ‘solutions’ to stagflation are simple. ‘Solution’ however is used very broadly here. If your problem is inflation and you want to stabilise the currency, you need to decrease the money supply. If your problem is de-growth, then you want to heavily invest in resource exploration and efficient production technologies. Supply constraints are physical and need physical technological solutions. In time of course, these technology changes will occur through native human ingenuity, and production will be able to increase once again. If you problem is the environment, stick with the stabilising the currency and let de-growth take its natural path.

Peak oil and the financial crisis.

We have reached the lowest oil price for about a year – down around $70 a barrel from a peak of over $140 a barrel not so long ago. Is this a sign that the theory of peak oil, that at some point the rate of global oil extraction will peak, is false, or at least is not here yet? I suggest the recent pattern of oil prices, and the financial upheaval around the world, are signs that we are very close to the global peak of oil production. I will attempt to explain why this is the case.

First we need to catch up on some economic principles. The price of a good is a relative measure, and reflects how many other resources are required to produce it. Consider a $100 pair of shoes. The price basically represents that the shoe required $100 of other resources to produce it. Such things as labour costs, materials, rents, distribution, design, advertising, and so on. A $50 pair of shoes requires around half of the amount of inputs. When the price of shoes is on the rise, it reflects increasing requirement of inputs. Thus a rising price is a sign of increased inputs necessary for production. And this also means that these inputs to production cannot be used to produce other things.

Now consider what happened to the price of oil recently. Regardless of what you believe about hedge funds, short selling, or any other financial trickery, the trend was a steep price increase for that past two years or so. This is a sign that more resources have been needed to produce oil, and were subsequently not being utilised for other production. Thus, the total production of goods in the economy must eventually drop. This is exactly as peak oil theorists would predict.

But what of the recent price drop. Again, we have to wait and see what the trend might be in the longer term, but this is also consistent with peak oil theories. The point here is that over the long term, the relative price of oil and other commodities (apart form labour) will be relatively constant. When oil becomes more expensive, so do other goods that need energy from oil in their production. Only the overall output of the economy will fall. The price spike we have just witnessed may simply have been a speculative signal based on expectations of future growth that were never going to come true.

On another note, I keep wondering that if oil is a non-issue, why the US has made such a huge sacrifice in waging war in Iraq?

If I am right, and the rate of oil production has peaked this year, or will peak in the near future, this is not necessarily a bad thing. As long as this ‘crisis’ does not provide excuses to wage wars, we can continue living a rather luxurious lifestyle with a downward trend in production just as easily as we did on the upward slope of the past half-century. In time, technology will evolve and allow us to produce more once again. For an environmental economist, peak oil is blessing for the environment. If I am wrong a global recession is a nice rest of our environment anyway.

Flow

Contemporary economists know that money doesn’t buy happiness. I take that back. Economists have trouble even defining money or happiness. But they can use stone-age tools (aka the art of regression) to ‘prove’ to us what most societies have known for millennia.

This, however, is a problem. Traditional economic thought has at its core the concept of utility - the thing that individuals try to maximise, and that we as a society should also strive to maximise. In effect, it is their best attempt at defining happiness. Economists are now struggling to get past this fundamental happiness contradiction. I would like to add some thoughts from psychology that may help our understanding, and reveal the underlying evolutionary explanation of how happiness is achieved.

I will preface this blog by saying that the majority of the views I am sharing actually come from a book called Flow: The psychology of optimal experience, by Mihaly Csikszentmihalyi. He breaks down happiness into to components – pleasure and enjoyment. Pleasure by itself will not provide us with happiness. It is the type of experience we have when we do not invest psychic energy in an activity. It is passive. Pleasure may come from watching a movie, walking in the park, admiring a work of art, listening to music. Enjoyment on the other hand requires the investment of psychic energy. The flow experience is how one gains enjoyment, and it comprises eight components:
1. Confronting tasks that we have a chance of completing
2. Concentration
3. Clear goals
4. Immediate feedback
5. Removes awareness of worries and frustrations
6. Provides a sense of control over one’s actions
7. Concern for the self disappears
8. The sense of time is altered

Clearly, a life without confronting tasks and clear goals is inherently unrewarding. But this is exactly the goal of much of societies development in the past century. The goal has been to make life easy, with no confronting tasks, and give us more choice, and as I have suggested earlier, this ‘choice-overload’ leads to less clear goals.

Surprisingly, Csikszentmihalyi found that people experience flow more often at work than during leisure time. It is easy to imagine many working environments where the first 4 components of flow are readily available. Other places people experience flow is when playing computer games. In fact, the game design field is probably the greatest user of the principles of flow. You know how you start with easy levels. You acquire greater skills, and are then confronted with more challenging tasks. All the way, there is plenty of feedback, and two hours have gone by in a flash. Edward Castranova has written about how people are shifting from their real lives, into online gaming worlds in search of flow.

One of the most interesting parts of flow is that to continue to have flow experiences, you need increasing complexity of challenges, and of skills to meet them. As a society , we have basically taken away much of the challenge of living, and also taken away many of the skills necessary to learn in order to live. Many people cannot cook themselves a meal from fresh ingredients. They cannot mend their own clothes, repair their houses, cut their own hair, clean their own house – what skills do we have?

I would to propose an evolutionary explanation for this desire for flow. In essence, those who sought more challenges, and reached them, were rewarded. You can imagine a tribe of early humans seeking out new lands in the face of increasing numbers of predators. The reward for this desire to rise above challenges, and persevere until new lands are found, would be greater reproduction and survival rates. Those early humans who did not have this desire to confront challenges, would ultimately perish before they could reproduce.

The ironic part of all this, is that flow often occurs in the times of most hardship. Csikszentmihalyi found that many prisoners of war, and people who have were faced with major physical disabilities, actually experienced flow more often than those of us living cushy urban lives in the 21st century. While we may find much pleasure in our comforts, this will not bring us happiness.

So what can we do to increase flow? We need to acknowledge that the most vital part to this story is that flow actually is self-determined. You can actually learn to be happy. External factors play no role. It is how you interpret your external environment that determines your happiness.

With all this great detail about human motivation and happiness, I still wonder why economists seek explanations use outdated concepts like utility to explain our actions. By sticking with this underlying theory they are stuck with trying to see whether factors such as wealth, number of children, marital status, age or any number of external circumstance or events can provide happiness. They pursue this even though they know can never prove a casual link. I guess reality and economics don’t mix sometimes.

New wikipedia entry

Just a short note this time.

I have written a new wikipedia entry for the Rebound Effect - which many of you would know is the topic of my thesis. If you are interested in a brief summary of what I have been spending my time on this past year, take a look.

http://en.wikipedia.org/wiki/Rebound_effect_(conservation)

The Tyranny of Choice

No, the title is not original and there is a good reason for this – choices have long been a source of concern for many people. And in recent years, choices have grown at a rapid rate. The question posed by Barry Schwartz, author of the book The Paradox of Choice, is whether all this choice has improved the welfare of society. Or, as he suggests, has the dazzling array of choices put as all at a disadvantage. How does this paradox occur?

First imagine choosing an ice-cream flavour. First you go to a store with only chocolate and vanilla. You weigh up the benefits of each flavour against the other, and make a choice. If you choose chocolate, vanilla is what economists term the opportunity cost. It is the forgone alternative for making a decision. Every time we make a choice, not only are we choosing one alternative, we are choosing to forgo another.

No let’s consider an ice-cream store with 30 flavours. To make a decision here, you need to weigh up the benefits of each of the 30 flavours to decide which is preferred. This is no mean feat, considering the likely limitations in knowledge of each of the flavours. When we decide, the opportunity cost of the decision is any one of the 29 other flavours we have forgone. And quite simply, the more alternatives we forgo, the less likely we are to be assured that the decision we made was the best alternative. In fact, people are much less happy with the decision they made when there are more alternatives, even if it is definitely the best one for them. This is because there is only a slight benefit over the second best alternative, and people only judge outcomes on this marginal benefit.

Also, if we compare ice-cream flavours in a pairwise manner, which means comparing two at a time, to determine our preferred flavour, we end up with 2¬30 small decisions to make, equal to the one we made at the previous store when we only had to decide between chocolate and vanilla. This can often lead to decision paralysis, where we simply avoid the choice because the process of making a choice itself is such a burden that the ice-cream will not make up for it.

Decision paralysis can bee seen widely in everyday life. At the moment, a friend of mine is visiting from abroad, and is trying to make a choice about his direction in life. Because there are so many options to choose he cannot pick one over the other, and when he does choose, there will be a second best alternative very close to as good as the one he takes, which he will always compare himself to.

In behavioural economics experiments it has been clearly shown that too much choice is a hindrance. For example, consider those free taste tests you sometimes get at the supermarket. It has been shown that it is best not to give too many options. The taste tests that give less than five varieties get more people to buy any one of them than taste tests with ten or more varieties. Also, companies that offer only three or fewer alternative health insurance plans to their employees in the US, get a much higher uptake in insurance than those who offer between ten and thirty different plans.

This leaves us in a tricky situation. If we only derive satisfaction from the benefit we get from a choice compared with the next best alternative, than too much choice is bring down human welfare. It is making us unhappy. But is there an optimal amount of choice?

Valuing the apples and bananas

It has come up for discussion in blogs, at bbqs, and international conventions, but we are still no closer to a workable solution for valuing the environment. When I say environment, what I mean specifically are natural ecological systems. And when I say valuing, I mean determining the contribution of these systems to the welfare of humanity. The difficulty for environmental economists is determining the value of these ecological systems in a common measure with the value we derived from conventional consumption – that is, in dollar terms. If we can establish a value for the environment it becomes a simple procedure to evaluate the human welfare implications of any land development.

So how do we go about comparing apples (the welfare we gain from the environment) and bananas (the welfare we gain from consumption)? One approach often used is to estimate the contribution of one particular ecological service, for example pollination by insects, to the economic production (http://news.mongabay.com/2008/0916-pollination.html). But this conventional approach estimates the contribution of ecological services to the production of real goods – in the pollination example, the contribution to agricultural production. By this only tells half the story. It tells the banana story, as it only looks at the value to production. The apple story is the welfare we gain from pollination in terms of its role in ecological systems that provide us with clean air, water, and any other non-economic way it which it improves the human experience. We cannot maximise human welfare without an estimate of apples and bananas.

The only reason we have certainty that conventional consumption (the stuff money can buy) provides us with increased welfare is because we are willing to pay for it. If we are voluntarily willing to give up other consumption for consumption of that good we must be benefiting. But if we take this willingness to pay principle to the environment, we face some hurdles. First, imaging your willingness to pay for a day’s breathable air. For me, it is almost infinite (if there is no alternative way of getting breathable air). Then we can look at water. A man dying of thirst in the desert would pay his life’s fortune for a little clean water. So in a way, we could say that these environmental services we get each day for free are infinitely valuable.

But most of us still receive these free environmental services each day even though we have severely disrupted the ecological systems that support it. So how do we know whether development that destroys ecological systems leads to a reduction in the welfare?

These are just some of the hurdles we face when trying incorporate the value to humanity from the environment into consideration. If you know of other concerns, please let me know. This is a big topic that will be the focus of much future research.

Too fat to fail

I remember a quirky line from Richard Branson’s autobiography. It went something like this – if you borrow $40,000 from the bank and can’t repay, it’s your problem, but if you borrow $40million and can’t repay, it’s the bank’s problem. He was talking about borrowing to buy planes for Virgin airlines, but a similar principle applies in so many places – the larger your business, the more people who have an interest in keeping it going. This includes the lenders but also the employees, other firms that do business with you, and the customers.

The reason I raise this point is because of the US Federal government bailout of Freddie Mac and Fannie Mae - both private firms dealing in the secondary market for mortgages. While Fannie Mae is a former government agency, and was privatised in 1968, Freddie Mac is a wholly private company, chartered by the US congress in 1970 to provide competition in the secondary mortgage market. All assets of these companies are solely owned by the shareholders, who also reap the profits from their investment.

So we see an interesting dilemma. For an economist, competition between producers provides great benefits to society by responding to demands and pushing down prices. However, inherent in this competitive environment is that businesses will occasionally fail. Problems arise when firms become very large. You can imagine that if the Queensland bank Suncorp went broke – that’s 9000 people out of a job, not to mention the problems with people who are insured by them, and flow on effects to other businesses.

I think economists often forget that their model of perfect markets is far removed from reality. In this model there are a large number of buyers and sellers, and no barriers to entry. Any market with few players and high capital costs is not perfectly competitive. If a firm fails in these oligopolistic markets there can be quite a degree of social disruption. Governments see these social costs as motivation for bailing out large firms. The US, an icon of capitalism, has probably the worst track record for corporate bailouts, with the airline industry post 9-11 another example.

What is most interesting about the bailout of the two secondary mortgage market players is that the intention is to prop up the whole economy. But you don’t see the government propping up the family fish and chip shop, or the local grocer, even though that is their intention in the end. One must wonder what criteria is used to determine whether a corporate bailout will or will not occur.

It is a surprising that any government would go ahead and privatise an industry if they are going to guarantee the newly created private firm against bankruptcy anyway. One criteria for privatisation much surely be that the firm be allowed to go bust. In any case, the issue over excessive scale of corporate enterprise, to the point where failure of the firm creates massive social disruption, should be an issue for governments worldwide.

Any thoughts on this type of government involvement in private enterprise?

Change required for change - a common conundrum

I have witnessed an interesting trend from experts lately. And probably have for a long time, but only recently noticed. They all simply state the obvious - change can happen when change happens.

Maybe an example would help me explain. I watched an interesting movie lately called Where in the world is Osama bin Laden. The guy from Supersize Me goes in search of bin Laden, and along the way interviews an expert on the Middle East. He says, that peace will come, but whenever the process gets started, someone goes and blows something up. Only when people stop fighting for long enough can we begin the peace process. To translate – when peace comes, peace comes. The ‘process of peace’ is peace itself – so where on Earth do you start?

Another example. On the news a few nights ago, an expert on eating disorders said (and I’ll just paraphrase) “that people need to accept their eating disorder and overcome their emotional attachment before therapy can take place”. So, therapy only works if you’ve already cured yourself!

This got me thinking about the origins of change. If the experts can at best say that change comes because change comes, where did it really come from?

I think I’ve found an answer in agent-based computational modelling (ACM). What is that you might ask? Well it’s basically a computer tool that can show how the individual actions of agents (people) in an environment can generate order on a macro level. You simply give each agent a set of rules to live by, and then run the program. As the agents interact with each other and their environment, they simply follow the rules, and you often get amazing patterns occurring.

ACM has been used to show how cooperation can emerge from a population of selfish individuals. As they interact they learn how cooperation can bring beneficial outcomes. But occasionally one of the agents stops cooperating, and depending on the strategy of the others, they can all act selfishly again. But then, cooperation can build up once more.

There are parallels between this and the dilemma of peace in the Middle East. When peace appears to be on its way, one agent stops cooperating, then all the previous cooperation collapses. Then the whole thing starts again.

ACM also has found that long periods of cooperation actually reinforces cooperation by making individuals tolerant of small discrepancies from other agents. But at some point agents will begins to abuse this tolerance. They will free ride, until there are so many free-riders that the others stop benefiting from cooperation, and we start the process once more. The optimistic finding of one of these models is that after a few long periods of peace, a final period of peace emerged that was sustained until the limits of computational power. My only concern is that in this model agents lived forever, and my suspicion is that if agents reproduce, due to lack of experience of the population, the chances of getting to this point are much lower.

Anyway, the expert was right the peace is needed for peace.

The big feature of ACM is that radical changes can appear to happen spontaneously in an environmental where every agent is simple following the same set of rules. Individual actions change even though the rules they are applying stay the same. So the eating disorder person may simply one day ‘snap out of it’ simply because the unconscious, instinctual rules tell us to – just like the got us into it in the first place.

I would like some more examples of change requiring change if you have any.

Population - the forbidden debate

A newspaper article this morning got me thinking about the untouchable issue of population growth. It is available here. Basically, the article publicised the not so surprising fact that SE Queensland’s rate of population growth is slowing. But what it did mention was the causal relationship between the supply of housing and population growth.

If we are to believe this article then increasing the supply of housing causes population growth – it must be true if the opposite is true. We have probably heard the phrase ‘build it and they will come’. Such a saying did not gain popularity because it is irrelevant. It gained popularity because is very close to the truth. If you would like an rather academic discussion of Say’s law – the theoretical argument that supply constitutes demand, have a read here.

The main point I want to raise today is that population growth is not something we respond to, as the state government so often puts it. It is something that comes about in response to economic conditions. When there is a boom – high growth. When there is a bust – low growth. Just today I sat in a seminar on the impact of war on reproductive rates of women. And yes, the supply of men also has an impact on reproductive rates and population. Imagine how well we could plan cities, towns, and infrastructure, as well as putting away areas for conservation, if we knew which factors highly influenced peoples reproductive decisions. We could plan, knowing in advance, the flow on effects from our policies. I wonder how much discussion was had before the introduction of the baby bonus? Or even discussion of the need for such direct stimulation, if indirect means can be equally effective.

So why would I raise population growth as an issue. Because for an economist environmentalist, labour supply is an important component in determining the net environmental impact of society. The more people we have, the more man/woman hours can be put to work producing goods and consuming natural resources.

The question we need to ask ourselves is what population we would like? It seems pretty radical to think about this. It brings images of China, oppression, and a violation of peoples right to reproduce. But this need not be so. While the Chinese have targeted population growth directly, if we believe that external factors influence population growth, then all we need to do is manipulate these factors to give people incentive not to reproduce. If we want more growth – just build more houses.

Thinking about the little things

I want to take up a topic that probably not many other bloggers have dealt with – dog poo. Why is this an issue for an economist environmentalist you might ask? Because today I was chastised for letting the dog poo in the park, and it got me thinking about the inconsistency in many of our actions.

Now, I try and clean up after the dog when we walk – it seems ridiculous to leave dog poo on the footpath where it is likely to be stood on. But he doesn’t like doing his business out in the open, and generally finds a spot in a garden to do it (not a private garden, but I am trying to describe the type of area he likes). If this is the case, I leave it. And, this was the case today.

But it got me thinking about the whole dog poo in a plastic bag philosophy. I know that this type of regulation is trying to avoid poo all over the streets, but I sometimes see how ironic the situation can get. We go to get groceries and are told to refuse a bag, and then told in the next breath to get a bag for the dogs poo, which will then be trucked to some far away landfill, to wait thousands of years for the plastic bag to breakdown and be back on it’s way back through the ecosystem. And at the same time all of this is happening, we truck in poo from other animals of choice to put on the garden to help the plants grow. So after all of this, I get the feeling that no bag is a more logical choice.

Those who are very familiar with this blog would know that neither the use of poo bags, or not, will have an effect on the consumption of oil (of which the plastic is made). But is seems like an odd thing to keep people employed in the poo shipping business when a simpler alternative is available.

One further little thing I got thinking about is whether animal excrement is even a form of pollution. In some cases, we see ibis poo all over the ground and it bothers some people – the ibis are polluting our cities. But what about the poo of every other animal alive! What about koala poo? Surely koalas can’t be the perpetrators of pollution! Or would they be of they we nearby to our homes? We want nature close by, as long as it keeps to itself and we interact with it on our terms only.

Well, that’s just a small issue I’ve been thinking about today. Does anyone else think that animals can pollute? Thoughts on the poo bag conundrum?

Free will and determinism

A mighty debate has emerged in the corridors of Z block, where I have an office at QUT. As you might expect, I was the instigator of this debate. It all started innocently enough, when I proposed that we examine an article that suggests people do not know their own tastes and preferences (you can find a version of it here http://www.bos.frb.org/economic/wp/wp2005/wp0510.pdf).
If we do no know whether something is good or bad, and simply use our immediate environment for clues, where does our free will fit in? And does the concept even exist?

It is a hard thing to question the idea of free will, and that is probably because there is no agreement on a specific definition. I will try and narrow this down. The definition must certainly cover the notion that each individual is responsible for their own actions, as they are an expression of their free will. This enables us to differentiate actions as the result of personal will as opposed to the will of others. It must also entail the idea of choice. That the actions we choose to take were not set, and that we faced opportunities to exercise our free will to determine which choice to make. Free will must therefore be a necessary precondition for any personal responsibility.

My debate in the corridors started because I suggested that of course free will cannot exist, because free will itself must have a cause. An idea cannot come from nowhere. And if it could, why do we pursue scientific endeavour? If one thing can come from nowhere, what is to stop many other physical occurrences coming from nowhere? This lead nicely into the idea of determinism, which put simply, says that every cause has a cause. So if free will causes my actions, then something must cause my free will. In the article we examined, this free will was caused by the suggestions of the author during his experiments.

I might take this a step further. Recent experiments have shown that decisions that might have previously bee regarded as free will, can be predicted up to 10 seconds before they are made by scanning unconscious brain activity (see http://www.physorg.com/news127395619.html). So in that period between the prediction of the choice, does the participant have free will to change their decision? I suggest not. If you have seen any of Derren Brown shows, this type of control by the subconscious seems all powerful (you can read about him here http://www.derrenbrown.co.uk/ or check youtube for some interesting videos).

So if our decisions are caused by subconscious environmental cues, and are made before we even know it, where does this leave free will and personal responsibility? How can we convict a criminal for his actions when they are determined solely by his environment (and genes of course)? To turn this conundrum around, how would we convict an alternative criminal whose free will appears from nowhere? His defence would be that my free will just appeared in my brain and made me do it – it was beyond my control. So some level of causality is required, although my brain gets tired thinking about these issues. (maybe have a read of http://plato.stanford.edu/entries/freewill/)

These are some interesting issues, and point to the heart of scientific endeavour and our understanding of humanity. What are your thoughts? How would you define free will? And do you believe every cause has a cause?

Externalities v irrationality

I would like raise an issue that has been rattling around my mind for many years now. After spending time travelling to various countries around the world, trends regarding the attitude of countries to personal and community responsibility have begun to emerge. For example, in Canada ski resorts bomb for avalanches outside the skiable terrain and search these off-piste areas at the end of each day. In Austria, unless there is a danger of avalanche on-piste it is every man for himself in other areas. You find similar things around the cities. In Vancouver I noticed people cross the street wherever and whenever suits. In Brisbane you get fined for jaywalking. I’m sure you can think of many other ways that some governments choose to protect individuals from themselves, but fail to protect individuals from the actions of others.

An economist would take the stance that role of government is to protect property rights, and in particular, to rectify the externalities that occur when one persons actions incur costs on another. In all other ways, individuals should be able to rationally choose for themselves the amount of risk they are willing to take. Let’s take Australian smoking regulations as an example. The first point of call for governments was to protect individuals from themselves by requiring warning labels on packaging. It was not until very recently that governments stepped in to protect non-smokers from smokers in many public buildings with indoor smoking laws.

Another example is the regulation of bicycle helmets (which is unique to Australia). Governments seem so keen to protect cyclists from themselves but fail to provide any road space for cyclists, nor training of the appropriate treatment of cyclist by drivers in the licence test, to protect them from the actions of others (or maybe that’s why we need helmets).

While I’m on to the cycling thing, I also seem to choke all the way to work each day from the exhaust of the motoring public. Pollution of this nature is the classic example of an externality in economics. It’s great that I have a helmet to protect me from falling, but the actions of others are costing me my lungs! Fair enough, I drive too, but since I bear a cost from ‘road pollution’ I would be happy to bear the cost of strict pollution regulation. Remember, I should be able to act in any way I choose as long as it does not impose costs on others. I have no right drive if that is the case.

I know some of you are thinking that the helmet laws and smoking laws are there to save the community incurring the health care costs, but you'll see from my health care post that such preventative actions lead to increased rather than decreased health care costs. The main message here is that root of these issues on the accepted scope of the legal term ‘duty of care’. In some countries, the government is seen to have an overly tight duty of care to the public, while in others there is much more personal duty of care.

So what is the reason for such frustrations? Simply, it offends me that an adult member of society cannot take responsibility for their own actions, while at the same time is in a position of bearing the costs of the actions of others. Also, it worries me that we are breeding a society that bears no personal responsibility, and has legal recourse to blame others. We laugh sometimes at the outcomes of court cases in the US, but don’t think we are immune from such stupidity. Imagine a society where I could governments take responsibility for individual stupidity. Where would it end? I agree that governments should make an effort to create a safe society, but they should not take responsibility away from the individual. They should protect us from others and let us take the consequences of our own actions.

Any thoughts, or interesting examples that I have missed?

An effective approach to environmental issues

Those regular readers (Dan I’m thinking of you here) might get the impression I think we should do nothing for the environment, since ‘the system’ will just take over and our actions will be rendered either useless, or at worse, counterproductive. But there are some things I believe are effective, and should be doing now.

For starters, my previous blogs have made clear that without physical constraints resource consumption will continue at the maximum pace allowable by current technology. My ‘solution’ is to apply artificial physical constraints in some way before the true limits of the national or global resources are reached. The effect of such limits will be identical to when true physical limits will be reached – resource prices will rise and labour productivity will wane unless technology proceeds at a pace that more than offsets these price rises. I would expect that a general drop in production, which would appear as an economic recession, but I would also expect changing preferences of society resulting in new consumption habits, and also technology change to ease this burden on the well-being of society. This approach is an example of total supply side constraint, which is the only truly effective way to reduce resource consumption. Demand side constraints we have already seen to be next to useless in decreasing resource consumption (and associated land disturbance, pollution and other environmental woes).

This artificial limit could simply be achieved through traditional conservation – which means ‘fencing off’ some land areas we agree are untouchable. These areas will continue to provide society with those ecosystem services we take for granted but generally overlook since they fall outside the scope of any formal institution. Filtration of air and purification of water through the water cycle does not fall within national borders, nor is ownership of these services likely to exist, but they do have tremendous value to humanity. We should ensure a minimum level of supply of these services to society by taking some land out of the formal economic system, to be designated to the informal supply of ecological services.

In my version of this ‘solution’ (The inverted comma’s are to show that the solution is not without it’s own problems. The social unrest when incomes are going down and resource rich land is lying untouched nearby is one of them) it is not simply a matter of taking some land already untouched an saying this now protected, which has traditionally been the approach with national parks. I would suggest a more integrated approach that at it’s core rests on planning controls. Such controls can govern the extend to which land in employed within existing developed areas, and can actually be used to force rejuvenation of ecologically important areas such as wetlands.

This approach I believe will build robustness into our society in the face of future environmental problems. It will ensure that even if our formal economy suffers as a result resource scarcity, that the quality of life of the people will remain high due to continued supply of a high quality environment. Further, it will ensure space is available for future agricultural opportunities in a world of a new climate.

Even if the economic optimists are right, and resource shortages never pose a serious problem, implementing this type of approach still benefits society greatly by improving environmental conditions at home. And of course in the remaining economic realm of the land, our formal economy can function as it pleases with very little controls.

What do you think of this approach?

Recycling part 2

It appears that a little clarification of the effect of recycling is required. First, consumption of the raw resource MAY decrease – but consumption of other resources is likely to increase. This is probably the most important point in the recycling discussion. We can target a particular resource to recycle for what ever reason (it better be a good one), but this necessarily involves the sacrifice of an increased consumption of other resources.

Now to the issues raised by my lovely friends.

The first interesting point raised (thanks Angie) is that we are not recycling goods themselves, simply the packaging or vessel that delivers the good. How can these two things be separated in a physical sense? Without the vessel, the newspaper to deliver the news, or the bottle to deliver the drink, there is no news or drink – since we cannot consume these things without their complementary packaging. Even with the Internet, consuming news requires computing power and a global communications network for the delivery. You can take this to the extreme – cars deliver travel, computers deliver communications and entertainment, food delivers nutrition, clothes deliver warmth and so on. Quite simply, the physical goods we consume to deliver these human desires are the ‘best’ ways we can do it. This type of logic is an extension of Becker’s theory of the household, developed in the 1970’s to explain the way we organise ourselves to maximise the services that generate satisfaction rather than goods themselves (by the way, he won a Nobel prize for his work, and if you want to read some more about it start here).

Moving on.

The graph below shows world aluminium production since 1976, including primary and recycled aluminium, and confirms many of the key principles I espouse. To begin, it appears that the quantity of recycled aluminium is not the major cause of changes in the quantity of primary aluminium production. The fluctuations in the primary production line (pink) are not correlated at all with the recycled production (yellow) line. If we look at the trend between 1983 and 2000, we see that both the quantity of recycled AND the quantity of primary aluminium production is rising.

But of course, you may like to argue that primary production would have risen faster without recycling – and I would argue that recycling actually enabled primary production to be higher than it otherwise would have been. Because time series evidence of one commodity cannot provide evidence either way, we need to resort to some kind of theoretical argument.

The comment was made (again, thanks Angie) that a new equilibrium quantity of new and recycled materials will emerge – this is definitely true. I am not saying that this new equilibrium quantity of new glass is always higher (but it can be). But this new equilibrium almost always mean the total consumption of both new and recycled material be higher than before, and the price of goods made from these materials will be lower. The aluminium graph supports this stance. Total production is higher (and rising very steeply) but unlike this graph, primary production does not need to continue to rise, and this ‘extra’ material can all be sourced by recycling.

Of course there are limits to recycling as well. Not all of this can be sourced from recycling. Many of the goods made from aluminium have quite long lifetimes (think construction materials, car and bike frames and so on), and will not be available to recycle for many years. Thus if we reach this limit, either new production will begin to increase more rapidly, or substitute resources will be found (with their own associated environmental problems).

One point I have tried to make clear is that resources saved are not spared, but only spared from one use to be employed in others. Unless there is some limit (and a physical one will do) the consumption of raw materials will continue to expand. I will save a thorough exposition for another time, but read ‘Jevons paradox and the myth of resource efficiency improvements’ by Polimeni, Mayumi, Giampietro and Alcott, or ‘Why conservation fails’ by Herbert Inhaber.

Many people find this idea hard to grasp. I would like to step through a couple of thought exercises to get this message across. First think back to the movie ‘The Gods must be crazy’. If you don’t know the one, a glass bottle falls from a plane onto the head (if I remember correctly) of an African tribal man. This bottle is found to be quite useful for starting fire, crushing seeds an many other applications, and causes hilarious disruption to the tribe. But the message here is that by reusing the bottle, it enabled the tribe to be more productive, and consume more nuts, berries, and other resources. Without the bottle, their resource consumption would have been lower than what it is with the bottle!

Alternatively you could think of a subsistence farming family in Cambodia. Imagine they have a large harvest and trade some food from a large can of kerosene for their lamps. When it is all used, instead of throwing away the can, they use it to store water for their trip to the local river. So now, because of this reuse of the can, they need to take less trips for their daily water, and have more time to work the land, thus enabling them to produce more, have more surplus, and trade for more kerosene – and the cycle goes on. It is our very innovative and productive uses for materials that cause as increase in consumption of them.

Another comment on the previous post is that a reduction in costs from recycling will not necessarily result in a reduced price of goods, but may be taken as profit. But what then will happen with the profits – they will inevitably be spent on some kind of consumption. This is the rebound effect, and it the reason I believe that recycling will generally lead to increased consumption of other resources. For example, even if recycling resulted in a reduced consumption of a single material/resource, because as a society we are not spending less on that material, we will be spend more on others.

Another thought experiment is probably helpful. Think of two households. One household sees kids in the other household using brand new paper for colouring, and offers some used (on one side) paper for the kids thinking that it will ‘save’ paper. The trade/gift takes place. Now the kids are colouring the back of old tax returns (or something). But has this decreased consumption of paper, or resources as a whole? Each household has the same income as ever, and therefore the ability to consume goods. The money saved by using old paper for the kids colouring is simply going to be spent elsewhere. Not necessarily on paper of course, but on some resource – maybe fuel for the car for a trip to the coast?

This type of flow on effect is why I believe the message that recycling cannot reduce resource consumption in total is so important. When one resource becomes very expensive as natural limits are reached, it stimulates substitution of that resource with another. When many of these limits are reached, total production may begin to fall unless we can use the limited quantity of inputs more efficiently. But if recycling encourages more resource consumption in total, we are simply accelerating our approach to these limits.

What about a ban on recycling then? Would this be more effective? It would drive up the prices of some raw materials, subsequently driving up the price of final consumer goods, which means we would consume less of them. But of course this price rise would encourage substitution towards other cheaper materials. If we banned glass recycling, for example, we might see more plastic bottles and cans.

Maybe we should not get too carried away with our passionate environmental stance until we get to the bottom of things.

Recycling not such a great solution

It would be hard to find an environmentalist who does not see recycling as a way to reduce resource consumption, and subsequently improve our natural environment. But there is no clear evidence that the emergence of recycling has reduced resource consumption. In fact, there is a solid theoretical argument that recycling has limited impacts on decreasing consumption of the targeted resource, and is likely to increase consumption of other resources. This alone should not be controversial to economists, but the real question is why we continue to perpetuate the myth. Let’s start digging to the bottom of this mystery.

I’m not really sure how to explain this succinctly, but I will give it a go. It is best to have in mind throughout this explanation a particular material – think glass, paper or aluminium. There are two cases to consider – one in which recycling is subsidised by the government, and one where it begins via market forces.

Imagine that the glass industry realises that it is cheaper to source glass through recycling then from sand mining. If recycling was not an option, glass would be more expensive than what recycling enables it to be. Because glass is cheaper due to recycling, it enables the industry to produce glass products more cheaply, creating a higher demand for these products. Of course, glass is rarely a final product itself, and thinking of bottles here, cheaper glass and products will require more caps, labels, cartons and shipping. Furthermore, because of the access to recycled glass has decreased demand for new glass, the price of new glass may fall, encouraging greater consumption. In all, recycling can reduce the consumption of new resources by a much smaller amount than first thought, and can increase consumption of other resources. In fact Valerie Thomas, in the Journal of Industrial Ecology, shows that second hand goods (the equivalent of recycling) can actually increase the consumption of those goods with large second hand markets.

The second type of recycling, the subsidised variety has similar results. It artificially makes recycled materials cheaper and therefore makes the goods made from both recycled and new materials cheaper – again increasing demand for the resource in question, as well as complementary resources.

So why then, if recycling can at best result is a minor reduction in resource consumption and an increase in consumption of other resources, and at worst result in an increase in consumption of the resource in question as well as others, do we persist in advocating it as an environmental cure all?

I would suggest the reason is simply that environmentalist do not know any better. Also, if you acknowledge that recycling is not effective it leaves very few options remaining that do not involve radical social upheaval. Governments must surely know about the ineffectiveness of recycling, but perpetuate the myth as a way of appearing active on the environmental front.

The most important point to take from this is that recycling may very well be counterproductive. Shouldn’t we at least know if what we are doing is helping or harming the environment?

Is it enough that it just is?

I have always been inquisitive - the one who asks the question ‘but why?’ more times than could be answered to any satisfaction. More recently, my concern for the precarious state of our natural environment lead me to associate with many other concerned individuals and organisations. They all promoted an agenda to suit their specific problem – the old growth forests, the wild rivers, oil depletion, climate change – but forgot to first ask the question ‘but why?’ Many of the so-called solutions were ill conceived and down right counter-productive. So began my search for the root cause of environmental problems as a means to discovering the real potential environmental remedies.

Along the way there were many stumbling blocks, probably the main one being the acceptance of the difference between normative and positive analysis. What most of us see in our daily lives is normative, that is, we seek to tread a path to what should be. Positive analysis on the other hand simply describes the way things are, without prescribing the value judgment necessary to determine the ‘should be’ of normative analysis. It appeared that almost all environmentalists had their own independent versions of what ‘should be’ without first understanding ‘what is’, and therefore where subject to classic mistakes of logic.

The shear impossibility of the task of determining the ‘should be’ on a societal level lead me to a more positivist arena, where through scientific rigour, causal links in the real world could be investigated (for those interested look into Arrow's impossibility theorem).

At this point I have reached an ideological standoff. Quite simply I now believe that ‘what is’ is always exactly what ‘should be’. A Darwinian view proclaims that all causes themselves have a cause, and as such, there is a reason for the present state of the universe. But reason or cause does not imply purpose, which is truly the issue at hand. In the environmental scenarios I have witnessed, the question of purpose is never contested, and often is never even given. ‘Save the old growth forests’ is printed in a banner in my neighbourhood, but I must ask why? At the risk of getting off track, I will follow the logic of a ‘why’ inquiry into the subject of old growth forests.

“Why do you want to save the old growth forests?”
“Because they are a habitat for wild species, they are rare, and they are beautiful”

“Why do you want to save wild species, and why are these things beautiful?”
“Because they are part of the natural ecosystem”

“Why do we need to save the ecosystem?”
“Because it supports life in Earth”

“Why do we want life on Earth?”
“Because….”

And so on.

To truly ask why, you must dig until you reach a point of sum ultimate point, which is – what is the purpose of anything? And now I have come to the realisation that rather than invent some purpose for which I will believe the universe exists, I will accept that there is no point, that it just is. Unless you specify what you believe the ultimate purpose of existence may be, then you cannot advance the opinion that one thing is good, while another is bad.

To bring this discussion back into line with the environmental theme presented earlier, I would say to those in the environmental community to please ask themselves the ‘why’ question. Unless they can clearly express the ultimate purpose of the universe, then they cannot simply announce to the world that what they believe is good, and what others are doing is bad. Also, since it is impossible to determine the preferences of society as a whole, we are still left without a social benchmark upon which to measure whether the progress we make as a society is a step in the right, or the wrong direction.

For those who feel like this is all a bit bleak, that there is no purpose to the universe, be assured that this does not imply you cannot strive towards some purpose in your own lives. By accepting the universe as is, you can have the freedom to determine you own purpose. But if my view is too simple, dull and downright pessimistic I would advise you to take heart that just because there is no purpose to it, does not make the world any less an intriguing, complex and glorious place than it was. To quote Richard Dawkins – “science is the poetry of nature”, although it only seeks to explain ‘what is’ does not make it any less wonderful.

Illusions of waste – a distraction for the masses

The oft-repeated mantra of the ‘ecological modernist’ is that we are wasteful. They see the rise of disposable cups, packaging, and plastic bags as a sign of that wastefulness. Further, in terms of energy and climate change, they see traffic jams full of cars with only the driver inside, and lights on in buildings with no occupants in the city all night – a society squandering our resources. If only we could stop all this wastefulness and build a utopia.

I will try and persuade you that the opposite is true. We are no more wasteful than we ever have been. In fact I will take it even further, by trying to persuade you that there is no solid principle upon which to even propose a concept of waste. Shall we proceed?

It is probably easier to start with the example of money. Quite regularly I hear people say “don’t waste your money on that.” What do they mean here? If it is something you would like, however silly the reason for that is, and you are willing to sacrifice any other consumption the money would have allowed you, then it cannot be waste. Think about it. Isn’t something wasteful to one person but not another? The relative and opinionated view of waste is highlighted in the caricature below.

“The environmentally conscious Prius driver looks at the large 4WD, with no passengers except the driver, sitting in traffic and thinks “what a waste.” The man behind them both on a motorcycle thinks “what a waste for just one person.” Beside him is a cyclist who looks at them all and thinks “what a waste of petrol when you can ride.” The walker on the footpath looks at the road with the 4WD, Prius, motorcyclist and cyclist and thinks “what a waste when you can just walk.” The quiet and thoughtful introvert looks out the window from the top storey of their house and thinks “what a waste – they’re all going to watch motor-racing anyway.” The neighbour across the street looks from the balcony of their small apartment to the thoughtful introvert in the window and thinks “what a waste – that whole house for one person.” Where does it end!”

See the confusion? Waste is a relative concept. What one person thinks is waste is clearly not to another person. You can imagine the most frugal individual today looks like the most wasteful one of a century ago. But surely you say, something must be waste – what about rubbish, and all that excess packaging? (Excess – compared to what I might say?)

First, we can take a look at rubbish. Isn’t rubbish simply something that is past its useful or valuable life? Is rubbish waste? If we adopt the definition that when an object is past its useful life it is rubbish, and also waste, then everything we have ever, and will ever produce as a society is ultimately waste. Nothing lasts forever, so even our houses, buildings and streets are waste. In fact, if it wasn’t for a short period of usefulness to humans at the time, all humanities great historical feats are waste – the pyramids, the Parthenon, all waste. It’s just that what we see daily as waste are those things produced for very short periods of use. Packaging has a use. The type of packing we see from the supermarket preserves food, enables easier transport and informs people of the contents. But there was plenty of other packaging along the way that we don’t see, which equally served a useful purpose. We just happen to see much of it at the end of its useful/valuable life.

Why then does it appear that there is more waste then ever? Simply because there is more production now than ever in the past. This enables many materials to be cheaper, and used for purposes with less value - but these purposes are generally for some positively-valued use.

This leaves three options:

1. Believe that waste is a useful concept – to do so you must determine an arbitrary but absolute baseline from which the relative concept of waste is determined. 
2. Believe waste is a concept but not particularly useful - that it describes a good at the end of its useful life, in which case everything humanity has ever produced is waste, or 
3. Believe the concept of waste has no underlying foundation and is therefore useless. 

Personally, I am would regard myself as one of the leaders of the third group. I would say the popularity of waste as a concept in environmental circles is, in fact, slowing progress on environmental issues, as it distracts from the core problems of which natural resources we will allow to enter our produciton system, how much of them, and where to but all produced objects at the end of their life.

Thoughts anyone?

Health care - an economist environmentalist perspective.

There are a number of issues I want to publicise on this blog, all of which challenge the economic and social orthodoxy that so rarely provides causal explanations and the ability to make even simple predictions. Today, I want to explain the predicament of public health care with two simple theories, both of which have somehow escaped much focus from mainstream economists.

It is best to start with what one would expect the health care current situation to be, and where the fingers are currently pointed. With the rapid technological advances in medical treatments, and the rapid reduction in price of almost all medical treatments including preventative measures, one would expect a healthier society and lower costs for running the healthcare system. But instead the system is in a funding crisis (as is the case in many countries), and people are seeking medical treatments more than ever. The finger is being pointed from some corners at the bureaucracy, for inefficiently providing services, and from other corners, simply to a shortage of funding. But would improving the efficiency of the system and the funding relieve the current pressures? I suggest not.

It is probably time to introduce the first theory to explain why I say this. It is known as Baumol’s disease, and describes how costs of production rise due to improvements in labour productivity in other sectors of the economy. In his classic example, William Baumol shows how improvements in labour productivity in other sectors of the economy (for example in farming, mining and manufacturing) lead to increased costs for playing a string quartet. Since individuals have a choice of whether to supply labour in the industries with increasing wages due to productivity improvements, or to the string quartet, the salary of the musicians must rise to attract them away from the other industries. If we replace the musicians with nurses, doctors and hospital administrators, we can see that it is our improved productivity in other areas that is causing this rise is health costs (as well as most other services). One might argue that productivity is improving in health professions as well, but a nurse making their rounds still needs as much time as ever, even if they are checking more medical vital signs.

The second theory that helps to explain the situation in health care is a broad interpretation of Jevons paradox. The theory explains that the efficient use of a resource does not diminish its consumption, but in fact increases it. The theory was developed in response to improvements in the efficiency of the coal fired steam engine, but it nevertheless applies to more broad cases. To begin this intuitive explanation one fact must be made clear – almost half of the medical costs a person incurs in their lifetime are incurred in the last thirty days of their life. With a little thought it is clear to see why this is the case. What has happened is that improvements in medical treatments have enabled us to live longer lives, and because of much of the preventative treatments, we die less suddenly then ever, increasing these 'death postponing' medical costs. Because we can diagnose more problems, we can visit doctor more readily, we treat more medical conditions then ever. Thus, it is because of the very efficiency and effectiveness of medical technology that our demand for it has grown, both during our lives, and in our ‘prolonged death’.

This harsh reality escapes almost every economist looking to improve the health case system. If we continue to improve productivity elsewhere in the economy, health costs will rise, and on top of this, their own technological breakthroughs lead to further demand for medical treatment. An analogy that might be more accessible is the idea of the paperless office. We have had wonderful improvements in the efficient provision of paper, but also elsewhere in the economy to actual produce the documents we wish to print. In all, paper use has risen dramatically, and if not for the reduction in real costs of paper (the opposite case to the labour of medical profesionals) the costs would have also sky-rocketed.

There is no easy way to reduce the health care burden. Actually, burden is not the right word, for health care itself supports much of society. Without it, there would be less of us, less of us in a healthy condition, and less production elsewhere in the economy. Looking in this way, those politicians who believe in productivity and growth might actually want to invest more in health care, due to the flow on benefits. For those who think less growth is the way to go because of environmental concerns, be aware that this goal conflicts with that of improved health spending, and improved health and life expectancy of the people.

What a complex world.

Is energy different from other resources?

In the face of global environmental challenge in the form of climate change, energy generation has become a target for governments and environmentalists alike. If we are not trying to use less of it, we are trying to generate it from other sources. But I often wonder why energy is treated any differently from any other resource. I also worry that a solution to climate change involves other environmental costs that will offset any improvements made. In fact, what scares me most is that we will find a clean and very cheap energy source – what the environmentalist may prize, I view as catastrophe wating to happen. Let me explain.

Quite simply, I see energy as a resource just like any other physical resource such as iron or timber. The reason is simple, use of these resources reduces labour effort required to produce goods. Also, they need to be combined with other resources to have any practical use. For example, a shovel reduces the labour time required to dig a hole. It could be made from timber, iron, steel, or any material. In the same way, a bobcat reduces the time to dig a hole by combining steel, plastic, rubber, and numerous other materials with oil and labour to produce holes. The energy from oil is just another physical requirement.

This leads to my climate change concern. To use less energy for a given purpose, we need to substitute energy for other resources. For example, a more energy efficient light bulb uses much more material and energy in its manufacture to use less during its useful lifetime. My concern then is that is a quest to be energy efficient, our requirements of other materials, and especially highly processed and polluting materials such as aluminium and mercury will drastically rise. The worry is that some materials we develop on our quest for energy efficiency will cause their own environmental disasters.

So what about the cheap and clean energy of the utopian dream? When we picture energy as just another physical resource we can see the problem clearly – this virtually ‘free’ energy is useless alone. It will require combining with other materials to make the machines and gadgets we desire. Furthermore, what is it we actually do with energy? We don’t build friendships and satisfy our spiritual desires. No, we use it for mining, transport, fishing, farming, and all the industrial processes of the economy.

If we are concerned about the environment, one might wish to become less energy efficient, or to have more expensive energy – both have the same effect. But the problem of technological developments is that they are irreversible. Once we know how to do something, we cannot unknow it. However we are finally learning the way our economy and environment interact. If only this knowledge can be put to good use, rather than as an excuse for further economic development.

What does the economy produce? Hunger, humans or happiness?

It occurred to me recently that the economic system does not really produce anything. From our individual perspective it appears that many goods and services are produced... but what then? Adam Smith famously said that 'consumption is the sole end and purpose of all production', so everything we produce is subsequently consumed, leaving us with...?

We might think that this makes no sense. We produce goods to consume them - that is the purpose and the point. But what happens then? We consume goods and services and then we supply our labour to produce more goods and services, which are ultimately consumed and so one and so forth.

The economist would say that we produce utility. That is, some kind of happiness or satisfaction in each of us from the act of consumption. But much research suggests that happiness is determined internally once some basic human needs are met. So if all this production and consumption is not producing happiness, what is it producing?

From a physical perspective, some ecological economists have suggested that all the functions within an economy are interdependent. We think the production as a one-way street, but the consumption of food, housing and entertainment is necessary for the supply of labour, which goes back into production. It could be imagined that there is no real production in the economy. It is simply a system that enables humans to fulfil their basic biological desire to reproduce and support a growing population. We could then say the economy produces people, but that again would be arbitrarily confining the system, since as suggested earlier, people are a functional part of the whole.

Maybe this is a strange way to view the world. A system without purpose that produces nothing. But in fact, Darwin would suggest that is a good way to describe it. That is how he described biological systems - a system based on variation, inheritance and selection, with no forethought or purpose. We are just animals after all.

Anyway, for those out there who like to blame the political, economic or banking system for the world's ills, and think there must be some alternative, relax. There isn't. Many of the world's problems, from poverty and human rights issues, to environmental issues stem not from our institutional systems, but from greater biological evolutionary systems that blindly created humanity in the first place. Any political or economic system will suffer the same fate.

So please relax and enjoy yourself - because happiness comes from within.

Amory Lovins - a crackpot with a mo!

The world media is full of optimistic talk of a future hydrogen economy and soft energy paths courtesy of Amory Lovins. Most famously he coined the term 'negawatts' to describes energy savings from energy efficient gizmos. For some reason, otherwise intelligent people have jumped on board the scam train and preached that the best thing we can all do is use energy more efficiently, and there will be not need for more energy generation capacity.

Rather than waste more time, I will bluntly show the absurdity of this claim. I currently eat one banana a day, but could eat them more efficiently, resulting in me eating just one per week! Each week I am now producing 6 negabananas! Surely there is no reason to clear the forest for banana planations since we can all consume them more efficiently! Lovins however takes the whole 'negascam' thing even further. He says that consumers should be paid to produce negawatts. Seriously, I produce an thousands of negawatts - I could plug in flood lights into all the electricity sockets in my home, using thousands of real megawatts (hours that is) but I don't. Therefore, I am instead producing thousand of negawatts. Where is me cheque?

The reality is our global economic system requires energy, and for the system to grow, we either need more people, or more energy available per person. It is a simple as that. Our choices are to continue using more energy each year and maintain growth, or use less energy and have negative growth.

My list of problems with economics

1. That most theories are base on some equilibrium position. Ceteris paribus, the world should converge to this point. However, this clearly has not happened, and is not likely to in the future. So what value are these equilibrium models?

Wouldn’t a better way be to explain the processes that cause constant changes? Rather than observing given situations, would it be better to know the processes that create the situations from previous ones? This is where evolutionary explanations come into play. The theory of evolution describes how such causal processes behave. An understanding of these processes may bring a whole new foundation to economics – where rather than focus on determining absolute outcomes, we focus on determining absolute processes, which, when given current starting points, will determine future paths.

2. Macro economics for the most part does not know what it is measuring, and therefore, cannot be much use in explaining our world. What are real incomes? What is the ‘price level’, when the type of goods in the economy continually change? If there is a price level, what is it relative to? Why is unemployment a bad thing when government benefits are provided? Do we value our time so poorly, and money so highly? Furthermore, there is a distinct lack of causal explanation for many of the phenomena observed. One observation of and abstract construct correlates with another observation of an abstract construct. Neither of which are known to the agents who make the decisions.

3. The great illusion of technology. Economists use the term ‘technology’ to explain everything the cannot explain. In the Solow growth model, technology is simply a residual term that captures everything that is not labour and capital. Can we really be so ignorant about the process of economic growth? Also, environmentalist have got the whole process backwards with regard to technological improvements in resource efficiency. Historically we know that such improvements cause increased resource consumption – how can they all of sudden start doing the opposite?

I’m sure there are many more, but that should be enough for today.

Sustainability is not about small actions – it is about human nature

Imagine you work as a reporter for a newspaper. due to your extreme environmental concern you decide that if you didn’t write your articles every day, then the paper they are printed on would be saved. As a compromise, you make sure to halve the length of each article. Further, if just one reporter from each newspaper around the world would take such actions, you imagine that many thousands of tonnes of paper would be saved.

Such a scenario describes the thinking of most conservationists, but it is fundamentally flawed. For starters, the newspaper must fill each page with something, so it may very well choose to fill the space with advertising or some other extended articles. Also, the publisher will seek to expand circulation, which itself requires more paper. Your actions have achieved nothing.

This is symbolic of the world we live. Small actions get absorbed by the economic machine, resulting in at best a substitution of resources and environmental problems. Even very large commitments will be absorbed by other global players.

The machine is not the ‘economic system’ the banking system or any other human construct. It is humanity. We are animals with inbuilt desire to reproduce. We seek out ranking above others to increase our reproductive chances, and we seek innovative ways of increasing the productivity of our labour time. To make any real environmental improvement means changing humanity. Or we simply wait till our rapid species explosion is brought into balance by our environment, and start all over again. It is not pretty, but that is sustainable. Repeated waves of human population expansion, fuelled by genetic desire for reproduction and rank.

Some have argued that we can create cultural forces that override these genetic desires, such that seeking rank and productive innovation are frowned upon. This may be the case. The luddites live in a similar fashion. But it takes only one ‘bad egg’ to come to power to stimulate these desires once again.

This is my thought of the day

Vegetarianism and the environment – a different angle

“It takes soo much less land to produce a calorie of energy from vegetables than from meat. If only we all ate less meat we could free up so much land from farming.”

This type of message is heard quite often, especially around my suburb, which is renowned form its high concentration of hippies. But on what basis are such claims made?

There is no debate that less land is required for a vegetarian diet than an omnivorous one. The debate centres on whether widely adopting vegetarianism is likely to result in an improved environment.

Let us meander through a thought experiment. Imagine the world today, and the present diet of the people, and then imagine that in one day 95% of people decide to become vegetarian. Meat industries of the world collapse while grain and vegetable farming expands rapidly. At this point the world is fed on the new diet, and some land previously used for grazing is now vacant. This is the utopia envisioned in the quote above, but what happens next?

The world does not stand still, that is for sure. There are many flow-on effects. The typical diet will now be cheaper, allowing money to be spent elsewhere. Not only will this consumption have environmental impacts of its own, but the increased level of wealth will allow a population increase. Such a rise in population will result from increased life expectancy afforded by increased wealth. More people will also require more resources. The likelihood of such effects offsetting the reduction in land used for meat production on the net environmental condition of the globe is uncertain.

What is certain is that such a narrow justification for individual actions to reduce environmental pressure is misleading, and can often suggest the opposite result from the true eventuality.

Myths of demand side management

Some of you may have noticed businesses offering to install new efficiency light bulbs in your house for free. One example is envirocare.com. A lovely lady asked me at the local shopping centre lately whether I had heard about such opportunities. I had not. I took the brochure and continued my enquiries online. It seems that to be able to offer such amazing deals to residents, the company is actually producing greenhouse gas abatement certificates through these measures which they sell to other business to offset their own emissions. Such a system is based on principles of demand side management. But does this system have sound foundations?

A short story may highlight some flaws of this program. Joe is on a budget, and is known as the guy who is careful not to waste anything. He always turns the lights out when not in a room, and always switches off appliances. The offer of free efficient lighting seems irresistible. He arranges to have his all his light bulbs replaced by Envirocare. Now, that lighting costs him only one fifth of the price it used to, he leaves a light on out the front when he goes out and is much less concerned about turning lights around them home. Since he is now saving so much on electricity, he buys a bigger television, which he leaves on most of the day, and small bar fridge to make space for his beer. A year after the new light bulbs Joe’s electricity consumption is twenty percent higher than before. Where is the energy saving for which supports these abatement certificates?

The short answer is there is no energy saving in this story. If not for the reduction in electricity costs Joe would not have been able to expand his consumption to the new television and bar fridge. More precisely, there is a direct causal link from the efficient lighting and the increased electricity consumption. In this story, greenhouse gas abatement certificates have been created from nothing!

Demand side management is fundamentally flawed. It relies on the assumption that demand for electricity will remain fixed even when prices change. This assumption is false. When the price of lighting is reduced, demand for it will rise – Joe’s did. Also, as incomes rise demand for energy rises. Neither of these issues are considered relevant by demand side advocates, yet there is growing evidence that it is just as effective as doing nothing.

So where does this leave us? Is doing nothing an option? If doing nothing is better than doing something why can’t that be a conscious choice?

Personally, the I feel that clear relief is coming. Remaining reserves of oil and coal are depleting, and in due course, the rising costs of these energy sources will result in reductions in energy consumption. But it won’t be a pleasant and productive period. It will result in radical economic slowdown – there is simply no alternative.

Growth spurt draining the state dry

Cyclone Odette may have been the last chance to receive drenching rain to top up the parched dams of the southeast corner before the winter, and it passed by leaving just a few drops.

In the same week, the Federal Government announced it will fund the long-awaited $2.3 billion Goodna bypass, and yesterday I received a rebate from the State Government for installing a water tank.

The connection between these three events is water, and more specifically, the lack of this precious resource in the dams around southeast Queensland. As we enter our dry season under the imposition of level 5 water restrictions, residents are being expected to cut their domestic water use to a scarce minimum. To offer further incentive, the state and local governments are offering grants to install water tanks for residential buildings. But if the State Government and Brisbane City Council were truly serious about the issue, and serious about the long-term sustainability of the region, why are they now spending many billions on large infrastructure projects designed to encourage rapid development?

The connection between the water crisis and the rapid scale of development in Queensland is clear to many people. Not only do more people need more water, but the development of new homes, workplaces and infrastructure requires massive amounts of water before and during construction.

The water required in the production of goods is known as embodied water, and has been overlooked in the decision-making processes for development in the southeast corner. In construction projects, the volumes of embodied water are extremely high. Recent studies from Deakin University show that the embodied water of a three storey office building designed to high environmental standards is about 54,100 litres per square metre of space. This is the equivalent of 18 3000 litre domestic water tanks, six months' domestic consumption by one person, or enough drinking water for one person for 37 years.

In the Brisbane CBD alone there is an estimated 100,000sqm of office space expected to be constructed this year, which would use about 5.4 billion litres of our supply – almost equal to the domestic consumption of Bundaberg with a few million litres to spare.

To offer some ballpark figures on embodied water, the CSIRO has found there is about 140 litres of embodied water for every dollar's worth of steel, and 15 litres for every dollar's worth of concrete. Other less reliable evidence suggests there is in the order of 40 litres of embodied water per dollar spent on construction.

Based on these figures, one might wonder how much water is going to be required to build Campbell Newman's TransApex plan. The North-South Bypass Tunnel alone will use 280,000 cubic metres of concrete and cost in the order of $3 billion (or will it cost us 120 billion litres of water?)

And what about the other infrastructure projects which have been proposed, such as the Goodna Bypass, or those under construction?

Putting enormous pressure on residents to save every drop seems ludicrous among this wastefulness. Even if every person in Brisbane saved 10 litres per day this year, it would be the equivalent of about 4 percent of the embodied water of the NSBT.

If the State Government is serious about water, it must get serious about limiting the scale of development in southeast Queensland. When you find yourself in a hole, you stop digging. When you find that you have outgrown your natural resources, you stop growing.

First Home Owners Grant has driven the housing affordability crisis

There has been much publicity recently about Australia’s growing housing affordability crisis. And quite justifiably. The 3rd Annual Demographia International Housing Affordability Survey released earlier this year puts Sydney, Hobart, Perth and Melbourne in the 25 least affordable housing markets in a study of Australia, New Zealand, United Kingdom, Republic of Ireland, United States and Canada. Shocking research such as this study has put pressure on the Federal Government to relieve pressure through tax reforms and incentives. 

Young Liberal Micheal Janda, in an award winning essay, proposed that the First Home Owners Grant was a positive move to combat unaffordability, yet this has simply not been the case.

The FHOG was intended to assist first home buyers to offset the impact of the introduction of the goods and services tax (GST). Apart from the obvious indirect relationship that GST and home buying have (since residential dwellings are GST exempt) and that the GST had impacts on all people, not just potential first home buyers, there is startlingly clear evidence to suggest that the FHOG was the stimulus for a reduction in affordability since 2000.

From the 1st July 2000, home buyers who had not previously owned their own property were given $7,000 by the federal government. Immediately, the price of housing in all areas would rise by at least this amount, for a first home buyer could offer for example $5,000 more for a property and still be $2,000 better off than another buyer. 

 In an instant, prices all residential markets rose by $7,000. 

Not only were the buyers who were already in a position to buy now helped along, but those who could not have been in the market except for the grant had started buying. This lead to an increase in potential buyers in any given area, thus an increase in aggregate demand for residential property, and following basic economic principles, an increase in prices. So not only were prices increased by $7,000, but also the flow on effects of a larger pool of buyers lead to further rises. Of course, looking at other flow on effects, or transformational effects, it could be stated that this rise in prices stimulated even more speculative investment, thus leading to a positive feedback cycle where as prices are seen to rise, more investment is made, raising prices even further. In property terminology this would be labelled a boom.

Addressing housing affordability is not a simple task, and like many other crisis, there is no silver bullet. Solutions will need logical foundations and sufficient time to wind back the crisis without causing other new crises. The call from the property development lobby to rezone more land for development is another counter-productive suggestion. There is already surplus land with development potential. But developers must wait for prices to rise before they can develop it. Can you imagine a property developer moving in to an area and selling below current market prices to forse the market down? It will not happen.

One of the best suggestions to address this crisis is a gradual movement of tax subsidies away from investment property to owner occupied dwellings. Currently, all maintenance expenses, interest on loans, and depreciation are all tax deductible for investment property. For your own home, you get nothing except a tax break on capital gains tax if you sell.

For a home purchased for $400,000, the tax benefits to the investment buyer over the home owner could easily exceed $15,000 dollar per year. The comprises of tax deductible interest and depreciation of the building, as well as rates and insurance costs. It makes the FHOG look like a token gesture.

Let’s get serious about the issue, and get people into their own homes. The benefits of home ownership to communities around Australia should be acknowledged and acted upon today.

Why phone and internet plans are meant to be difficult to understand

Have you ever spent the morning on the phone trying to find the best deal on a new phone line and internet plan? It seems that every company has something new and different to offer; specials package deals, bonus calls, free modem, or free installation if you sign up for the two-year contract. The options are endless. 

If we measured the competitiveness of a market by the amount of customer choice, the telecommunications market would certainly have to be regarded as highly competitive. Mobile phones are perhaps even worse. With loyalty programs, free phone upgrade and phone insurance, and any number of other nifty deals to persuade customers into believing they have the best deal. In the end, it was the toss of a coin that made the decision for me. Not one of the plans, after strict comparison and scrutiny, seemed any better or worse than the others. In fact, it seemed that all the companies were offering the same product, for the same price, but packaged with any number of confusing ‘bonuses’ and ‘specials’. And there is a logical reason for this situation, which doesn’t quite fit with the Howard Governments belief that privatisation provides more efficiency through more competition.

It must first be stated that the benefits of a perfectly competitive market cannot be ignored. When there are low barriers to entry, new firms can easily enter the market to compete, and since the products are so comparable and customers have complete information, they can make the simple choice of purchasing the cheapest product offered. In this model, the cheapest, and therefore the most efficient producers become profitable, while the least efficient producers are forced out of the market. And if those who remain in the market begin to raise prices, it is easy for competing firms to enter and profit by undercutting the competition until the prices fall. 

Unfortunately, this theoretical market model does not actually exist in the real world. Like in physics, where a theory requires a frictionless environment, there can be no application of this theory until the limitations of the model have been addressed. And the most serious of these limitations for the perfect market are the product comparability and the complete information available to the customer.

By consciously manipulating these two criteria of a free market, all firms in the market are able to avoid a state of true competition that would produce the most efficient allocation of services and are able to artificially inflate the value of the commodity, hence producing more profit for each firm in the market. This is not meant to sound like a conspiracy because indeed each firm does not need to meet in back rooms with the other firms in the market and all agree to limit customer information and the comparability of their products. They each simply need to aspire to the great marketing ideal of product differentiation, a concept that is fundamentally designed to artificially eliminate direct competition by removing direct comparability.

The power of product differentiation, through its ability to remove comparability and create an information gap to distort what could be a perfectly competitive market, can be demonstrated by the case of the term life insurance market in the US in the late 1990s. There was a mysterious and dramatic drop in prices across all firms that did not correlate to price drops in other forms of insurance, which themselves were steadily rising. 

According to economist Steven D. Levitt, this can be attributed to the realisation of a perfect market through the power of the internet. Although term life insurance policies had been quite homogeneous before this period of time, the process of shopping around for the cheapest price had been convoluted and time-consuming, whereas websites such as Quotesmith.com suddenly made the process almost instantaneous. In just a few years, the value of the term life insurance market in the US had dropped by USD$1bilion because of the new-found ease of comparability. What insurance firm would want this to happen? Even if you were a small player in the market, say a 1% market share, your turnover had just dropped by $10million. It is perhaps one of the great recent examples of the power of perfect competition in allocating resources efficiently, yet possibly one of the greatest blunders by the insurance industry.

Let us now return to the Australian telecommunications market. It is quite possible at the moment, that no two companies offer an identical phone or internet plan. The process of comparing the plans to find the best deal is currently convoluted and time-consuming (much like in the previous insurance example), and the products have been differentiated in seemingly all possible ways. Recent websites are attempting to remove this information lag and do the comparison with a double click, but may only be adding to the confusion as telecommunications providers further differentiate their products through packages and bonuses, and modify their plans more frequently in the name of incomplete information.

Imagine now if all firms in this market offered the same three identical plans - a low use package, a mid use, and a high use, all with identical call rates, fees, contracts and download quotas. What would happen to the market? Would, as in the case of term life insurance, prices plummet and leave the market with a dramatically decreased total value? If we are to believe in the ideas of Adam Smith and other advocates for more competitive markets, the answer must be an astounding yes. The real catch to this whole affair is that more competitiveness would only benefit the customers, and not the powerful and influential telecommunications firms, and not the federal government.

For the ideals of the Howard government of revenue raising through privatisation of public assets to make any sense, you must believe that in private hands, the markets will work competitively and hence benefit the customers, also know as the Australian people. But evidently, it will not.