EC The World’s Weird Self-Organizing Economy

Why is it so difficult to make accurate long-term economic forecasts for the world economy? There are many separate countries involved, each with a self-organizing economy made up of businesses, consumers, governments, and laws. These individual economies together create a single world economy, which again is self-organizing.

Self-organizing economies don’t work in a convenient linear pattern–in other words, in a way that makes it possible to make valid straight-line predictions from the past. Instead, they work in ways that don’t match up well with standard projection techniques.

How do we forecast what lies ahead? Today, some economists believe that the economy of the United States is in danger of overheating. Others believe that Italy and the United Kingdom are facing dire problems and that these problems could adversely affect the world economy. The world economy should be our highest concern because each country is dependent on a combination of imported and exported goods. The forecasting question becomes, “How will divergent economic results affect the world’s economy?”

I am not an economist; I am a retired actuary. I have spent years making forecasts within the insurance industry. These forecasts were financial in nature, so I have had hands-on experience with how various parts of the financial system work. I was one of the people who correctly forecast the Great Recession. I also wrote the frequently cited academic article, Oil Supply Limits and the Continuing Financial Crisis, which points out the connection between the Great Recession and oil limits.

Today’s indications seem to suggest that an even more major recession than the Great Recession may strike in the not too distant future. Why should this be the case? Am I imagining problems where none exist?

The next ten sections provide an introduction to how the world’s self-organizing economy seems to operate.

[1] The economy is one of many self-organized systems that grow. All are governed by the laws of physics. All use energy in their operation.

There are many other self-organizing systems that grow. One such system is the sun. Some forecasts indicate that it will keep expanding in size and brightness for about the next five billion years. Eventually, it is expected to collapse under its own weight.

Hurricanes are a type of self-organizing system that grows. Hurricanes grow over warm ocean waters. If they travel over land for a short time, they can sometimes shrink back a bit and grow again once they have an adequate source of heat-energy from warm water. Eventually, they collapse.

Plants and animals also represent self-organizing systems that grow. Some plants grow throughout their lifetimes; others stabilize in size after reaching maturity. Animals continue to require food (a form of energy) even after they stabilize at their mature size.

We can’t use the typical patterns of these other growing self-organized systems to conclude much about the future path of the world’s economic growth because individual patterns are quite different. However, we notice that cutting off the energy supply used by any of these systems (for example, moving a hurricane permanently over land or starving a human) will lead to the demise of that system.

We also know that lack of food is not the only reason why humans die. Based on this observation, it is a reasonable conclusion that having enough energy available is not a sufficient condition to guarantee that the world economy will continue to operate as in the past. For example, a blocked shipping channel, such as at the Strait of Hormuz, could pose a significant problem for the world economy. This would be analogous to a blocked artery in a human.

[2] The use of energy products is hidden deeply within the economy. As a result, many people overlook their significance. They are also difficult for researchers to measure. 

It is easy to see that gasoline provides the energy supply needed for our cars and that electricity provides the power needed to clean our clothes. What is missing? The answer seems to be, “Everything that makes humans different from wild animals is something that was made possible by the use of supplemental energy in addition to the energy from food.”

All goods and services require the use of energy. While some of this energy use is easy to see, other portions are well hidden. Energy used in manufacturing and transport is most visible; energy used in services tends to be hidden.

Governments are major users of energy, both for their own programs and for directing energy use to others. Retirees get the benefit of goods and services made with energy products through pension checks issued by governments; researchers get the benefit of goods and services made with energy products through research grants they receive. Wars require energy.

Medical treatments are possible because of the availability of medicines and equipment made with energy products. Schools and books, as well as free time to study in schools (rather than working in the field), are possible because of energy consumption. Jobs of all kinds require the use of energy.

One thing we don’t often consider is that if energy supplies are growing sufficiently, they permit an expanding population. In fact, expanding population seems to be the single largest use of growth in energy consumption (Figure 1). Growing energy consumption also seems to be associated with prosperity.

 

Figure 1. World energy consumption growth for ten-year periods (ended at dates shown) divided between population growth (based on Angus Maddison estimates) and total energy consumption growth, based on the author’s review of BP Statistical Review of World Energy 2011 data and estimates from Energy Transitions: History, Requirements, and Prospects by Vaclav Smil.

[3] Prices of energy services need to be low relative to overall costs of the economy. Falling energy costs relative to overall GDP tend to encourage economic growth.

Most economists expect energy prices to represent a large share of GDP costs if energy is truly important. The statement above says the opposite. There are at least two reasons why low energy prices, and energy prices that are truly falling when inflation and productivity changes are considered, are helpful.

First, tools (broadly defined) used to leverage the labor of human workers often require considerable energy to manufacture and operate. Examples of such tools include computers, machines used in manufacturing, vehicles, and roads for these vehicles to drive on. The lower the cost to purchase and operate these tools, relative to the benefit of the tools, the more likely employers are to purchase them. If energy costs tend to fall over time, it becomes progressively easier to add more tools to leverage the labor of employees. Thus, employees become increasingly productive over time, raising the economy’s output of goods and services. For a similar reason, rising energy costs, if not offset by efficiency gains, present a barrier to economic growth.

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Moon Kil Woong 3 months ago Contributor's comment

Actually the world needs a cheap, dense, and hopefully safe electric energy storage system more than anything else. This would solve a lot. For energy production, the big hope is geothermal and/or fusion although modern nuclear power plants are much safer as well. Solar helps as does wind energy, but it won't solve our growing energy needs, especially without a dense efficient way of storing it.

Gary Anderson 3 months ago Contributor's comment

I would not feel comfortable having nuclear power close to earthquake faults. Maybe it is just me. But there are other alternatives, but as the author says they are not necessarily enough to bridge the gap. So, energy affordability and proper pricing is very important to the economy. Americans are buying expensive large vehicles more and more. This could squeeze energy in the future.

Vivian Lewis 3 months ago Contributor's comment

there are circumstances in hot developing countries where solar energy off the grid doesn't require subsidies. Where the background is right the same is true of wind power or tidal energy. In places like Iceland and Kenya geothermal power makes sense. It is wrong to assume that these alternatives to oil and gas won't grow more important. And I happen to think nuclear power also often is a suitable option.

Gary Anderson 3 months ago Contributor's comment

Yes, nuclear may have its place. I just happened to be on the middle of a major earthquake out west and on the edge of another one. I think they should be avoided where the ground won't stay still.

Vivian Lewis 3 months ago Contributor's comment

Moon Kil Woong is right about the need to have a storage system for intermittant power like solar or wind. The sun doesn't shine for 24 hours and the wind doesn't always blow. I have a stock for this but it is a long-shot, a geothermal company from Nevada which also is developing storage systems, Ormat, ORA. It is not a global-investing.com pick because it is a US firm, and moreover its share has been beaten down over the volcanic eruption in Hawaii just down the road from its shut-in geothermal power plant. I take a long view.