Thermodynamic Critique Of Economics

The first major economist to criticize neoclassical economics on thermo-dynamic grounds was Nicholas Georgescu-Roegen (hereafter G-R). He is best known for his 1971 book, The Entropy Law and the Economic Process (Georgescu-Roegen 1971). To summarize in the fewest possible words, his key point was that the economy is not a perpetual motion machine. In contrast to the standard neoclassical view, the economic system is a materials-processing system that converts high quality (low entropy) raw materials into goods and services, while disposing of, and dissipating, large and growing quantities of high entropy materials and energy waste (that is, waste heat). The economic systems of less developed countries are still driven by solar energy converted by photosynthetic plants into food and feed for human and animal workers. The economic systems of advanced industrial countries are driven mainly by exergy that was captured and accumulated hundreds of millions of years ago in the form of fossil hydrocarbons.

G-R understood, and emphasized many times, that economic goods are of material origin, while even immaterial services are almost all delivered by material goods or systems. It follows that processing raw materials into finished materials, machines, objects and structures (goods) requires a supply of available energy (that is, exergy). Moreover, the production of services, from transportation to communications to protection, also requires a flow of exergy. But for his unfortunate insistence on a so-called fourth law of thermodynamics (his phrase was 'matter matters'), he would probably have accepted the view of most physicists that exergy is the 'ultimate resource' (for example, Goeller and Weinberg 1976).

How then can exergy and the second law play a central role in economics? A few authors have invoked thermodynamic concepts as a way of conceptualizing the interface between the natural environment and the economic system, that is, the extraction, recycling and dissipation of resources (Berry 1972; Berry et al. 1978; Cleveland et al. 1984; Cleveland 1991; Costanza 1980, 1982; Costanza and Daly 1992; Daly 1986, 1992). This approach has become known as 'biophysical economics'. Others have probed the relationship between entropy, information and evolution (Prigogine et al. 1972; Prigogine and Stengers 1984; Faber 1985; Faber and Proops 1986, 1989; Faber et al. 1987, 1995; Ayres 1994a). Others have focused on the integration of natural capital into economic theory. Still others have tried to apply thermodynamic and economic ideas in ecosystem theory (Odum 1971, 1973; Hannon 1973; Kay and Schneider 1992; Brooks and Wiley 1986).

Possibly the most ambitious effort, so far, to integrate thermodynamics, economics and ecology has been by Matthias Ruth (1993). His perspective is summarized, in the introduction to his book, as follows:

Economists' arguments - originating in the Walrasian tradition - suggest that under ideal conditions economic agents anticipate all relevant future costs associated with the use of matter and energy, and act rationally such that their choice of actions are reconciled on a complete set of current and future markets. At any given moment in time prices subsume all information on the availability of materials and energy, direct their optimal allocation, and induce the introduction of substitutes and the development of new technologies. Since substitution is assumed to be always possible, the scarcity of energy and materials is just a relative one. Thus the conclusions drawn from studies based on the Walrasian tradition are dominated by arguments of adjustment possibilities. . .

. . . Although during the past several decades economists have made tremendous advances in the relaxation of assumptions necessary to describe and analyze economy-environment interactions, physical interdependencies of the economic system and the environment receive attention only if they are associated with prices and costs.

We would have added the word 'explicitly' in front of the phrase 'associated with prices and costs'. It is precisely these physical interdependencies that Ruth seeks to clarify, as we do also. Here is another more recent view by Sollner (1997, p. 194):

. . . environmental economics is faced with a profound dilemma: on the one hand, thermodynamics is highly relevant to environmental economics so that thermodynamic concepts seem to have to be integrated somehow to redress the deficiencies of neoclassical economics. On the other hand all approaches toward such an integration were found to be incomplete and unsatisfactory. On the basis of the neoclassical paradigm, thermodynamic constraints are able to take only the first law of thermodynamics into consideration, whereas the implications of the entropy law cannot be given due regard. But the radical alternative of an energy theory of value was even more of a failure . . .

The most perceptive, albeit tangential, critic of the treatment of energy in economics has been Philip Mirowski in his book, More Heat than Light (1989). Mirowski makes a case that some will find persuasive, namely that neoclassical economics suffers from 'physics envy'. The most obvious example of physics envy is the use in economics of the Lagrangian-Hamiltonian formalism for optimization, borrowed from 19th-century mechanics. Mirowski points out something that most economists are probably unaware of, namely that the use of this optimization technique presupposes the existence of an underlying conservation law. In 19th-century physics that law was the conservation of energy, as formulated in the 1870s. In neoclassical economics, the analog of energy is utility. Hence the implied conservation law in economics refers to utility, although the assumption is almost never made explicit. It is ironic that the actual laws of thermodynamics, which are highly relevant constraints upon the possible outcomes of real economic transactions, are neglected in neoclassical economics.

Looking more closely at how energy has been incorporated up to now into theories of production, and in particular production functions per se, we note an apparent inconsistency. Energy is not consumed. Yet, capital is consumed (via depreciation) and labor-hours are consumed. Why then include energy in the production function if it is a conserved quantity? The answer is, of course, that the terminology is misleading: the available part of energy (known as exergy) is not conserved at all.

In Chapter 3 we noted that exergy is defined as the maximum amount of useful work that can be extracted from a given amount of energy. It is sometimes regarded as a measure of energy quality. As energy is transformed into less useful forms according to the entropy law, exergy is destroyed. It is only the useful work from consumed exergy that is productive and that should therefore be included in the production function. Unused exergy, associated with material wastes released into the environment, including waste heat, is what we understand as pollution. At worst, pollution may be directly harmful to people's health; more commonly, the harm is indirect, as when fisheries are destroyed. To minimize harm requires countermeas-ures that cost money or inhibit economic growth. On a practical level, the problems of treating and disposing of waste exergy-containing materials, or waste heat, invariably require additional expenditures of exergy.

Perhaps the best example is that of atmospheric greenhouse gas (GHG) emissions - mainly carbon dioxide, but also methane, nitrous oxide and some other chemicals - from the combustion of fossil fuels and other industrial processes. There is no doubt that the useful work provided from 'energy carriers' such as fossil fuels has been central in providing the mechanical power to operate machines and drive processes that contribute to economic activity and growth. But GHGs also drive climate change.

Climate change has real costs, from droughts and floods to sea-level rise and, over time, the shifting of biomes from south to north, and loss of biodiversity.

But the carbon dioxide in the combustion products remains in the atmosphere for a century of more and when it is finally dissolved in the oceans, it remains in and acidifies the surface waters. Future costs to mankind are incalculable but potentially enormous. Current expenditures to limit carbon emissions are increasing, but represent only a small fraction of the eventual monetary (and exergy) requirements just to stabilize the climate and prevent further damage. The costs of reversal, that is, a return to the pre-industrial climate, are incalculable because the climate system is probably irreversible, at least by any means known, or at any tolerable cost.

For us, the answer to Sollner's discouraging assessment of the state of environmental economics (ibid.) is to incorporate exergy, and second-law efficiency, explicitly into an endogenous alternative to the neoclassical theory of economic growth. Indeed, the normative implication of Georgescu-Roegen's world-view, slightly re-stated, is that - thanks to second-law irreversibility - it is essential to utilize scarce exergy resources of all kinds (including metals and minerals) more and more efficiently in the future. In other words, increasing efficiency is the key to combining economic growth with long-term sustainability. Luckily, or perhaps unfortunately, depending on viewpoint, the efficiency with which raw material input (exergy) is currently converted into final services is still fairly low. Hence there is plenty of room for improvement, at least in the near and medium terms (Ayres 1989b). The long term must probably approach Herman Daly's elusive steady-state (Daly 1973).

It follows that, if the economy is a 'materials processor', as G-R evidently believed, and we concur, then useful work (exergy services) ought to be one of the factors of growth. We think that, after some grumbling, G-R would have agreed with the approach adopted hereafter.

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