Background

The methodology described in the previous chapters is obviously too complicated to be applicable to developing countries with, in many cases, short histories and incomplete or unreliable historical data. Yet there is an increasingly urgent need to develop better forecasting and scenario-analysis tools that are simpler to implement and that do not depend from the outset on two critical but risky assumptions. The first assumption is that global economic growth is automatic and exponential, that is, that it depends on exogenous technological progress - or 'total factor productivity' (TFP) - which increases each year by something like 2.5 percent, on average, despite short-term fluctuations. The second critical but very risky assumption is that it (the growth trend) is independent of energy consumption and, therefore, independent of energy production and availability.

The dangers of making long-term policy decisions, and long-term capital investments, based on faulty assumptions, need not (indeed, cannot) be addressed here. However, it is worthwhile pointing out that a variety of organizations, including the World Bank, the International Monetary Fund (IMF), NATO, OPEC, the OECD, the Inter-governmental Panel on Climate Change (IPCC), the executive branches of the European Union (the EEC) and major national governments, routinely base policy decisions on long-term scenarios that incorporate such assumptions, albeit usually hidden.

Policies to respond to the challenge of global emissions of carbon dioxide and other greenhouse gas (GHG) emissions clearly depend upon forecasts of economic growth and energy consumption. Rapidly increasing demand for energy, especially by China and India, has introduced a significant new element into the equation. The likelihood of a peaking of global petroleum

* This chapter is based on a paper by Jie Li and Robert Ayres, entitled 'Economic Growth and Development: Towards a Catchup Model', in Environmental & Resource Economics, 2007 (Li and Ayres 2007).

output within the next decade or so magnifies the problem.1 Finally, the fact that the bulk of known remaining petroleum resources is located in the Middle East, mostly in Islamic countries with unstable governments and rising Islamic fundamentalism, introduces a major uncertainty.

All the studies of strategies for minimizing the impact of climate change point to increasing costs of primary energy, whether by introducing carbon taxes, emissions regulation, carbon sequestration, or mandatory energy conservation technologies. Recent empirical and theoretical work suggests that the driver of growth is not energy (exergy) consumption as such, but exergy converted to 'useful work' in the economy (Ayres and Warr 2002; Ayres 2002; Ayres and Warr 2003; Ayres et al. 2003; Ayres and Warr 2005). This strongly suggests that higher energy prices could have a negative effect on economic growth, at least in the US.

The realism of the core assumption (that only capital accumulation per worker drives growth) was sharply challenged by empirical studies in the early 1950s. Research based on reconstructions of historical time series of the supposed factors of production (labor and capital) drastically reduced the apparent role of capital per unit of labor (Abramovitz 1952, 1956; Fabricant 1954). For example, Fabricant estimated that capital accumulation accounted for only 10 percent of US economic growth since the middle of the 19th century.

Most economists are still using versions of a theory of growth developed for a single-sector model exactly half a century ago (Solow 1956, 1957; also Swan 1956). The theory was developed further by Meade (1961). A key feature of the Solow-Swan model was the explicit introduction of a generic aggregate production function in which capital services are derived from an artifact called capital stock, discussed in previous chapters.

The Solow model, in its original form, depends on only two independent variables, or 'factors of production', namely, total labor supply and total capital stock (Solow 1956, 1957). Labor and capital services are assumed to be proportional to the corresponding stocks. However, as noted already, these two variables or factors of production could not explain the observed growth of the US economy from 1909 through 1949. The unexplained 'Solow residual' accounted for over 85 percent of the per capita growth in output. Solow termed this residual 'technological progress' and introduced it as an exogenous multiplier of the production function. The multiplier is usually expressed as an exponential function of time which increases at a constant average rate of about 2.5 percent per annum based on past history. The multiplier is now called total factor productivity, and it is commonly assumed to be exogenous to the economic system. The unexplained residual is usually attributed nowadays to a stock of technological knowledge that grows (by assumption) according to some unexplained principle.

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