How Does the Economy Really Work?Our Finite World

How Does the Economy Really Work?Our Finite World

The global economy is a complex, physics-based, self-organizing system driven by three major elements: extracted resources including energy, human population, and financial demand. All three tend to increase over time, but both population and extracted resources hit limits due to the finite nature of the world.

Financial demand is often emphasized by politicians as it appears to grow without limit. However, the true limiting factor is the amount consumers can afford to pay for resources and the products they create. This extraction limit cuts off resource extraction at levels far below geological estimates, as higher prices make products unaffordable.

In this article, we’ll explore how the economy actually operates and the implications of our finite world. We’ll cover topics like economic cycles, the role of energy, technological advancements, global interdependence, and sustainable economic approaches.

The Concept of Finite Resources

The world economy is a dissipative structure – a self-organizing system that requires energy of the right kinds to sustain “life” and growth. Just as animals require food, the economy needs energy from sources like fossil fuels, biomass, or the sun to function.

This fundamental principle has been known since 1996, but is often overlooked. Humans have long adapted to using some cooked food, which enabled population growth. However, this pattern often leads to “overshoot and collapse” as populations expand until reaching local carrying capacity limits.

Today, human population is high relative to finite fossil fuel resources, and intermittent renewable sources like wind and solar are still proving challenging to fully integrate. We may be nearing the limits of this pattern of growth and collapse.

The Role of Energy in Economic Activity

Energy consumption is closely tied to GDP, as every economic activity requires energy dissipation. Physics tells us that all actions, even the movement of molecules, require energy. Within the economy, this energy can come from human effort, the sun, or sources like fossil fuels.

Debt is important because it helps “pull the economy forward” by enabling investments today that can pay off later. As long as the return on investment is high enough to repay the debt with interest, the system seems to work and GDP tends to grow.

However, if energy costs are very high or industries are stagnant, it may be difficult to get any payback from debt-financed investments. Interest rates may need to be very low, or debt defaults become likely, leading to low or negative economic growth.

The Limitations of Growth-Driven Economies

Simple models that assume the future will be like the past or that past trends will continue are often popular, as they suggest good times will continue indefinitely. But in a finite world, many patterns are constantly changing due to factors like resource depletion and population growth.

The 1972 computer model of the Club of Rome showed that if the share of resources needed to extract and transform resources becomes too high, the economy tends to collapse. Quick payback of energy investments becomes very important, as does the amount of specialized equipment like transmission lines and batteries required.

This suggests that technologies like wind, solar, nuclear, and LNG may struggle, as their energy payback is not immediate like oil, coal, and biomass. The latter require less specialized equipment for transportation and storage.

Boom and Bust Cycles

Politicians often try to create more debt to stimulate financial demand, as this can push money down to ordinary citizens who can then buy more goods and services. Historically, this has worked well when resource extraction was well within physical limits.

However, as we approach extraction limits, this approach becomes less effective. At some point, finished goods become too expensive for consumers if prices rise high enough to satisfy producers. Affordability is key.

Oil prices, for example, can’t rise too high for buyers or stay too low for producers. This pattern holds for other resources as well – prices tend to spike and then fall back, not being very acceptable to either buyers or sellers.

The Interconnectedness of Global Markets

The world economy is highly interconnected, and decisions made in one region can have global impacts. For example, China’s accession to the World Trade Organization in 2001 led to a massive shift of manufacturing to China, which drastically increased global coal consumption and CO2 emissions.

Complexity can take many forms, including greater specialization, more education, larger businesses, and greater globalization. While these changes can sometimes improve energy efficiency, they often add to overall energy demand. Complexity also makes the system more susceptible to breakdowns.

Another issue with complexity is that it leads to highly interdependent supply chains, making economies dependent on suppliers in countries they may be at odds with. This can allow countries to “hold others hostage” by restricting access to critical resources or components.

Sustainable Economic Approaches

Physicist Francois Roddier explains that growing wage and wealth disparities are to be expected when energy supplies are short and complexity is increased as a substitute. Wealthier individuals tend to get a disproportionate share of the available goods and services, while poorer people get squeezed out.

This dynamic is a major source of the conflict we are experiencing today. As the economy becomes more constrained, the competition for scarce resources intensifies, leading to greater tensions and inequality.

To address these challenges, approaches like a carbon tax with revenues redistributed to the population could help, but must be carefully designed to avoid offshoring jobs or merely shifting emissions elsewhere. Ultimately, humanity will need to grapple with the reality of a finite world and explore new economic models that are not reliant on perpetual growth.

The European Future Energy Forum is at the forefront of exploring these critical issues, bringing together policymakers, industry leaders, and sustainability advocates to chart a path towards a more sustainable future. By understanding how the economy truly functions, we can work to develop innovative solutions that work within the constraints of our finite planet.

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