Figure 1. Two views of the economy, (a) The neoclassical view of how economies work. Households sell or rent land, natural resources, labor, and capital to firms in exchange for rent, wages, and profit (factor payments). Firms combine the factors of production and produce goods and services in return for consumption expenditures, investment, government expenditures, and net exports. This view represents, essentially, a perpetual motion machine, (b) Our perspective, based on a biophysical viewpoint, of the minimum changes required to make Figure la conform to reality. We have added the basic energy and material inputs and outputs that are essential if the economic processes represented in Figure la are to take place (redrawn from Daly 1977).
Figure 2. A more comprehensive and accurate model of how economies actually work. The second column of this diagram represents the entire global ecosystem milieu within which the rest of the global economy operates. Natural energies drive geological, biological, and chemical cycles that produce natural resources and public service functions and maintain the milieu essential for all other economic steps. Extractive sectors use economic energies to exploit natural resources and convert them to raw materials. Raw materials are used by manufacturing and other intermediate sectors to produce final goods and services. These final goods and services are distributed by the commercial sector to final demand. Eventually, nonrecycled materials and waste heat return to the environment as waste products. We believe this diagram to be the minimum model of how a real economy works.
Some social implications of our analysis
If one accepts the importance of a biophysical basis for economics, then our analysis has some important implications for economics and for society.
The replacement of expensive labor in routine jobs with the combination of cheap energy and capital stock is likely to continue under the present incentive structure. This combination also reinforces the trend toward globalization, because goods and services produced in low-wage countries can be transported cheaply to high-wage countries. Thus, high unemployment (in most high-wage countries) will continue if the disparities between the productive powers and cost shares of labor and energy are not removed (for example, by adjusting fiscal policy). Certainly, the low price of fossil fuels relative to their productive power generates large profits. But, as is well known, it also prevents the market penetration of large-scale energy-conserving and nonfossil energy technologies, which could lower the demand for fossil fuels and relieve some of the burden of pollution. We therefore believe that the problems of unemployment, resource depletion, and pollution can be attacked successfully only if the pivotal role of energy as a factor of production is properly taken into account in economic and social policy.
Price does not always reflect scarcity and economic importance. Scarcity of a resource must be defined in terms of both short and long-term resource availability. Price, the economist's usual metric of scarcity, reflects many important aspects of scarcity poorly because it is often based on short-term market values. Most important, as Norgaard (1990) and Reynolds (1999) show, is that uncertainty about the size of the base of a resource can obscure the actual trend in scarcity of that resource, with the result that "empirical data on cost and price...do not necessarily imply decreasing scarcity" (Reynolds 1999, p. 165). As an example of this phenomenon, in mid-1999 the real price of oil was at nearly its lowest level ever, despite the fact that most estimates of the time at which global oil production will peak range from 2000 to 2020 (Kerr 1998, Cleveland 1999).
The concept and implementation of sustainable development as interpreted and advocated by most economists must be thought through much more carefully, given the requirement for energy and materials for all economic activity (see Hall 2000 for a detailed analysis of Costa Rica). Energy is in fact disproportionately more important in terms of its impact on the economy than its monetary value suggests, as evidenced by the events of the 1970s (i.e., inflation, stock market declines, reduced economic output, and so on), which appear to be re-occurring to some degree in 2000 partly in response to a similar proportional increase in the price of oil. Fundamentally, current societal infrastructure has been built and maintained on the basis of abundant, cheap supplies of high-quality energy—that is, energy characterized by the large amount of energy delivered to society per unit of energy invested in this delivery (through exploration and development or through trade of goods for imported energy [Hall et al. 1986]).
In developing nations, investment policies based on neoclassical economic analyses encourage borrowing from developed countries and hence growing indebtedness. Pressure to service the debt encourages the quick extraction of resources to generate a cash flow so that payments of interest and repayment of principal can be maintained. In the meantime, the long-term productivity of the region may be destroyed. But those assessments are not included in neoclassical analyses; in the rare cases where resources are included in the analysis, their value is heavily discounted. For example, many tropical countries sell their forest products at a price far below their worth (Repetto 1988, Hall 2000), and the Russian government has been talked into abolishing its export tax on fossil fuels, which was the last source of secure revenues for highly indebted Russia. Developing countries and nations in transition to market economies should attribute more importance to their natural resources than they presently do under the influence of the reigning economic theory.
Humans tend to seek political explanations for events that in fact may have been precipitated by biophysical causes. For example, Reynolds (2000) shows how the sharp decline in the former Soviet Union's oil production may have precipitated the economic crises that led to the collapse of the Soviet Union.
Some biological implications of our analysis
Economies, just like ecosystems—or indeed any system— can be represented as stocks and flows of materials and energy, with human material welfare largely a function of the per capita availability of these stocks and flows.
Present agricultural technologies, most wildlife management and conservation programs, and perhaps biomedical technologies are as dependent on the availability of cheap energy as anything else. For example, most increases in agricultural productivity have not come from genetics alone. In fact, for many crops there appears to be essentially no increase in gross photosynthesis but rather only an increase in the proportion of photosynthate that goes to the parts we eat, often seeds, while the organs and functions of a wild plant (e.g., growing roots to take up more nutrients and water, generating secondary compounds for insect defense) are increasingly supplied by industrially derived inputs from outside the plant (Smil 2000). In addition, the efficiency of agriculture tends to be inversely related to the intensity of use of land area or fertilizer (Hall et al. 1998, Hall 2000, chap. 12).
Human material well-being is derived essentially by redirecting energy stocks and flows from what natural selection and the accidents of geology dictated to ends determined by human needs and, increasingly, desires. Now some 40% to 60% of global primary production is exploited, in one way or another, by the human economy (Vitousek et al. 1986, 1997).
Outlook: The challenge to construct a model that includes the biophysical basis of the economy
Existing "economic" models cannot effectively represent a total economy, because none has a biophysical basis; some attempts to produce such a model have been made, however. First, there are very detailed and comprehensive models of the flow of energy through each sector of the US economy (Hannon 1982). But these do not include the flows of nature (such as the energy associated with the hydrological cycle, flows of rivers, solar energy, photosynthesis, and other important components of the economic system). Another approach, one that garners considerable controversy, does include the energy flows of nature and the human economy: This is emergy (with an "m") analysis, which also attempts to give each energy flow a weighting, according to its quality (Odum 1996). This approach has been applied at an aggregated level to national economies and used as the basis for policy recommendations (Brown et al. 1995).
Finally, evolutionary economics looks for ways to model the economic process by combining nature's principle of self-organization with the growth of human knowledge and innovations8 (Witt 1997, Faber and Proops 1998).
We must conclude, however, that a truly useful and acceptable model that includes the biophysical basis of the economy is probably still far in the future. What then is the utility of bringing a biophysical perspective into economics? We believe that it is overwhelmingly heuristic. By thinking about economies as they actually are (i.e., Figure lb or 2) instead of how we might conceptualize them for analytic ease and tractability (i.e., Figure la), we can teach a new generation of economists about the real operations of human economies and the various links to the "economies" of the natural world. We believe that doing so is especially important because science gives us to understand that there are at least constraints, and possibly even limits, to growth. Future generations of economists probably will not be able to treat such issues as overpopulation, oil and groundwater depletion, and changes in the composition of the atmosphere and the biosphere simply as "externalities" to be given a price and rolled into the larger analysis; these will have to be treated as fundamental components of the total economic model. We do not understand how that can be done without starting from a biophysical basis. We challenge a new generation of economists and natural scientists to think from this perspective.
--From article "The Need to Reintegrate the Natural Sciences with Economics", Charles Hall, Dietmar Lindenberger, Reinar Kümmel, Timm Kroeger, and Wolfgang Eichorn. BioScience • August 20011 Vol. 51 No. 8, page 663-73.