Source: Our Finite World
What do diminishing returns, energy return on energy invested
(EROI or EROEI), and collapse have to do with each other? Let me start
by explaining the connection between Diminishing Returns and Collapse.
Diminishing Returns and Collapse
We know that historically, many economies that have collapsed were
ones that have hit “diminishing returns” with respect to human
labor–that is, new workers added less production than existing workers
were producing (on average). For example, in an agricultural economy,
available land might already have as many farmers as the land can
optimally use. Adding more farmers might add a little more
production–perhaps the new workers would keep weeds down a bit better.
But the amount of additional food the new workers would produce would be
less than what earlier workers were producing, on average. If new
workers were paid on the basis of their additional food production, they
would find that their wages dropped relative to those of the original
Lack of good paying jobs for everyone leads to a need for workarounds
of various kinds. For example, swamp land might be drained to add more
farmland, or irrigation ditches might be added to increase the amount
produced per acre. Or the government might hire a larger army might to
conquer more territory. Joseph Tainter (1990)
talks about this need for workarounds as a need for greater
“complexity.” In many cases, greater complexity translates to a need for
more government services to handle the problems at hand.
Turchin and Nefedof (2009) in Secular Cycles took
Tainter’s analysis a step further, analyzing financial data relating
to historical collapses of eight agricultural societies in operation
between the years 30 B.C. E. and 1922 C. E.. Figure 1 shows my summary
of the pattern they describe.
Typically, a civilization developed a new resource which increased
food availability, such as clearing a large plot of land of trees so
that crops could be planted, or irrigating an existing plot of land.
The economy tended to expand for well over 100 years, as the population
grew in size to match the potential output of the new resource. Wages
were relatively high.
Eventually, the civilization hit a period of stagflation, typically
lasting 50 or 60 years, as the population hit the carrying capacity of
the land, and as additional workers did not add proportionately more
output. When this happened, the wages of common workers tended to
stagnate or decrease, resulting in increased wage disparity. The price
of food tended to spike. To counter these problems, the amount of
government services rose, as did the amount of debt.
Ultimately, what brought the
civilizations down was the inability of governments to collect enough
taxes for expanded government services from the increasingly
impoverished citizens. Other factors played a role as well–more
resource wars, leading to more deaths; impoverished common workers not
being able to afford an adequate diet, so plagues were more able to
spread; overthrown or collapsing governments; and debt defaults.
Populations tended to die off. Such collapses took place over a long
period, typically 20 to 50 years.
For those who are familiar with economic theory, the shape of the
curve in Figure 1 is very similar to the production function mentioned
in Two Views of our Current Economic and Energy Crisis.
In fact, the three main phases are the same as well. The issue in both
cases is diminishing returns ultimately leading to collapse.
There seems to be a parallel to the current world situation. The
energy resource that we learned to develop this time is fossil fuels,
starting with coal about 1800. World population was able to expand
greatly because of additional food production permitted by fossil fuels
and because of improvements in hygiene. A period of stagflation began in
the 1970s, when we first encountered problems with US oil production
and spiking oil prices. Now, the question is whether we are approaching
the Crisis Stage as described by Turchin and Nefedov.
Why Might an Economy Collapse?
Let’s think about how an economy operates. It is built up from many
parts, over time. It includes one or more governments, together with the
laws and regulations they pass and together with their financial
systems. It includes businesses and consumers. It includes built
infrastructure, such as roads and electricity transmission lines. It
even includes traditions and customs, such as whether savings are held
in gold jewelry or in banks, and whether farms are inherited by the
oldest son. As each new business is formed, the owners make decisions
based on the business environment at that time, including competing
businesses, supporting businesses, and the number of customers
available. Customers also make decisions on which product to buy, based
on the choices available and the prices of these products.
Over time, the economy gradually changes. Some parts of the economy
gradually wither and are replaced by new parts of the system. For
example, as the economy moved from using horses to cars for
transportation, the number of buggy whip manufacturers decreased, as did
the number of businesses raising horses for use as draft animals.
Customs and laws gradually changed, to reflect the availability of
automobiles rather than horses for transportation. In some cases,
governments changed over time, as increased wealth allowed more generous
social programs and wider alliances, such as the European Union and the
World Trade Organization.
In the academic field of systems science, an economy can be described as a complex adaptive system.
Other examples of complex adaptive systems include ecosystems, the
biosphere, and all living organisms, including humans. Because of the
way the economy is knit together, changes in one part of the system tend
to affect other parts of the system. Also, because of the way the
system is knit together, the system has certain
requirements–requirements which are gradually changing over time–to keep
the economy operating. If these requirements are not met, the economy
may collapse, just as the eight economies studied by Turchin and Nefedov
collapsed. In many ways such a collapse is analogous to an animal
dying, or climate changing, when conditions are not right for the
complex adaptive systems that they are part of.
Clearly one of the requirements that an economy has, is that it needs
to be wealthy enough to afford the government services that it has
agreed to. Scaling back those government services is one option, but
when these services are really needed because citizens are getting
poorer and finding it harder to find a good-paying job, this is hard to
do. The other option, unfortunately, seems to be collapse.
The wealth of an economy is very much tied to the availability of
cheap energy. A huge uplift is added to an economy when the (value added
to society) by an energy resource such as oil greatly exceeds its (cost
of production). Over time, the cost of production tends to rise,
something measured by declining EROI. The uplift added by the difference
between (value added to society) and (cost of production) is gradually
lost. Some would hypothesize that the falling gap between (value added
to society) and the (cost of production) can be compensated for
by technology changes and improvements in energy efficiency, but this
has not been proven.
Our Economy is Already in a Precarious Position
As I indicated in my most recent post, if a person computes average wages by dividing total US wages by total US population (not just those
employed), the average wage has flattened in recent years as oil prices
rose. Median wages (not shown on Figure 2) have actually fallen. This
is the same phenomenon observed in the 1970s, when oil prices rose. This
is precisely the phenomenon that is expected when there are diminishing
returns to human labor, as described above.
The reason for the flattening wages is too complicated to describe
fully in this post, so I will only mention a couple of points. When
consumers are forced to spend more for oil for commuting and food, they
have less to spend on discretionary spending. The result is layoffs in
discretionary sectors, leading to lower wage growth. Also, goods
produced with high-priced oil are less competitive in the world market,
if sellers try to recoup their higher costs of production. As a result,
fewer of the products are sold, leading to layoffs and thus lower
average wages for the economy.
In the last section, I mentioned that the economy is a complex
adaptive system. Because of this, the economy acts as if there are
hidden laws underlying the system, parallel to the laws of
thermodynamics underlying physical systems. If oil supplies are
excessively high-priced, very few new jobs are formed, and those that
are created don’t pay very well. The economy doesn’t grow much, but it
does stay in balance with the high-priced oil that is available.
The Government’s Role in Fixing Low Wages and Slow Economic Growth
The government ends up being the part of the economy most affected by
slow economic growth and low job formation. This happens because tax
revenue is reduced at the same time that government programs to help the
poor and unemployed need to grow. The current approach to fixing the
economy is (1) deficit spending and (2) interest rates that are kept
artificially low, partly through Quantitative Easing.
The problem with Quantitative Easing is that it is a temporary
“band-aid.” Once it is stopped, interest rates are likely to rise
disproportionately. (See the recent Wall Street Journal editorial,” Janet Yellen’s Greatest Challenge.”)
Once this happens, the economy is likely to fall into severe recession.
This happens because higher interest rates lead to higher monthly
payments for such diverse items as cars, homes, and factories, leading
to a cutback in demand. Oil production may fall, because the cost of
production will rise (because of higher interest rates), while the
amount consumers have to spend on oil will fall–quite possibly reducing
oil prices. If interest rates rise, the amount the government will need
to collect in taxes will also rise, because interest on government debt
will also rise.
So we are already sitting on the edge, waiting for something to push
the economy over. The Affordable Care Act (“Obamacare”) may provide a
push in that direction. Inability to pass a federal budget could provide
a push as well. So could a European Union collapse. Debt defaults are
another potential problem because debt defaults are likely to increase
dramatically, as economic growth shrinks, as discussed in the next
Debt is Major Part of our Current Precarious Financial Situation
If an economy is growing, it is easy to add debt. People find it easy
to find and keep jobs, so they can pay back debt. Businesses and
governments find that their operations are growing, so borrowing from
the future, even with interest, “makes sense.”
It is as also easy to add debt if the economy is not growing, but
there is an ample supply of cheap oil that can be extracted if
increasing debt can be used to ramp up demand. For example, after World
War II, it was possible to ramp up demand for automobiles and trucks by
allowing purchasers to use debt to finance their purchases. When this
increased debt led to increased oil consumption, it greatly benefited
the economy, because the (value to society) was much greater than the
(cost of extraction). Governments were able to tax oil extraction
heavily, and were also able to build new roads and other infrastructure
with the cheap oil. The combination of new cars, trucks, and roads
helped enable economic growth. With the economic growth that was
enabled, paying back debt with interest was relatively easy.
The situation we are facing now is different. High oil prices–even in
the $100 barrel range–tend to push the economy toward contraction,
making debt hard to pay back. (This happens because we are borrowing
from the future, and the amount available to repay debt in the future
will be less rather than more.) The problem can be temporarily covered
up with deficit spending and Quantitative Easing, but is not a long-term
solution. If interest rates rise, there is likely to be a large
increase in debt defaults.
The Role of Energy Return on Energy Invested (EROI or EROEI)
the ratio of energy output over energy input, a measure that was
developed by Professor Charles Hall. To calculate this ratio, one takes
all of the identifiable energy inputs at the well-head (or where the
energy product is produced) and converts them to a common basis. EROI is
then the ratio of the gross energy output to total energy inputs. Hall
and his associates have shown that EROI of oil extraction has decreased
in recent years (for example, Murphy 2013), meaning that we are using increasing amounts of energy of various kinds to produce oil.
In previous sections, I have been discussing diminishing returns with respect to human labor. Oil
and other energy products are forms of energy that we humans use to
leverage our own human energy. So indirectly, diminishing returns with
respect to the extraction of oil and other energy products, as measured
by declining EROI, will be one portion of the diminishing returns with
respect to human labor. In fact, declining EROI may be the single
largest contributor to diminishing returns with respect to human labor.
This will happen if, in fact, low EROI correlates with high oil price,
and high oil prices leads to diminished wages (Figure 2). This may be
the case, because David Murphy (2013)
indicates that the relationship between EROI and the price of oil is in
fact inverse, with oil prices rising rapidly at low EROI levels.
Contributors to Declining Return on Human Labor
Human labor is the most basic form of energy. We humans supplement
our own energy with energy from many other sources. It is this
combination of energy from many sources that is reflected in the
productivity of humans. For example, we take it for granted that we will
have tools made using fossil fuels and that we will have electricity to
power computers. Before fossil fuels, humans supplemented their energy
with energy from animals, burned biomass, wind, and flowing water.
What besides declining EROI of fossil
fuels would lead to diminishing returns with respect to human labor?
Clearly, the same problems that were problems years ago continue to be
problems. For example, growing world population tends to lead to
diminishing returns with respect to human labor, because resources such
as arable land and fresh water are close to fixed. Greater world
population means that on average, each gets person less. Oil production
is not rising as rapidly as world population, so the quantity available
per person tends to drop as world population rises.
Soil degradation is another issue, according to David Montgomery, in Dirt: The Erosion of Civilizations (2007).
Declining quality of ores for metals is another issue. The ores that
are cheapest to extract are extracted first. We later move on to poorer
quality ores, and ores in less accessible locations. These require more
oil and other fossil fuels for extraction, leaving less for other
There are other more-modern issues as well. Growing populations in
areas where water is scarce lead to the need for desalination plants.
These desalination plants use huge amounts of fossil fuel resources (oil
in the case of Saudi Arabia) (Lee 2010), leaving less energy resources for other purposes.
Globalization is another issue. As the developing world uses more
oil, less oil is available for the part of the world that historically
has used more oil per capita. The countries with falling oil consumption
tend to be the ones that recently have had the most problems with
recession and job loss.
An indirect part of diminishing returns with respect to human labor
has to do with what proportion of the citizens is actually able to find
full-time work in the paid labor force, and whether the jobs available
are actually using their training and abilities. The Bureau of Labor
Statistics calculates increases in output per hour of paid labor. I
would argue that this is not a broad enough measure. We really need a
measure of output per available full-time worker.
Obviously, there are potential offsets. We hear much about technology
improvements and increased efficiency offsetting whatever other
problems may occur. To me, the real test of whether there is diminishing
returns with respect to human labor is how wages are trending,
especially median wages. If these are not keeping up with inflation,
there is a problem.
We don’t often think about the return on human labor, and how the
return on human labor could reach diminishing returns. In fact, human
labor is the most basic source of energy we have. Stagnating wages and
higher unemployment of the type experienced recently by the United
States, much of Europe, and Japan look distressingly like diminishing
returns to human labor.
Stagnation of wages is happening despite attempts by governments to
prop up the economy using deficit spending, artificially low interest
rates, and Quantitative Easing. Without these interventions, the results
would likely be even worse. If QE is removed, or if interest rates rise
on their own, there seems to be a distinct possibility that these
countries will be reaching the “crisis” phase as described by Turchin
Historical experience suggests that a major danger of diminishing
returns to human labor is that governments costs will rise so high, and
wages will drop so low, that it will be impossible for the government to
collect enough taxes from wage-earners. In fact, there seems to be
evidence we are already headed in this direction. Figure 4 (below) shows
that the US ratio of government spending to wages has been rising
since 1929. Government receipts have leveled off in recent years.
Adding more health care services under the Affordable Care Act will
only increase this trend toward growing government expenditures.
One issue is how the financial benefit of human labor (together with
the energy sources leveraging this labor) is split among businesses,
governments, and humans. Businesses have the most control in this. If an
endeavor is not profitable, they can discontinue it. If cheaper labor
is available elsewhere, they can cut hold down wages in countries with
higher wages. They also have the option of increased mechanization.
Humans and governments both tend to get shortchanged. As the overall
return of the system reaches limits, wages of humans tend to stagnate.
Governments find themselves with greater and greater costs, and more and
more difficulty collecting funds from increasingly impoverished
Most authors of academic articles assume that the challenge we are
facing is one that can be solved over the next, say, fifty years. They
also seem to believe that the fixes required are simply small
adjustments to our current economy. This assumption seems optimistic, if
we are really approaching financial collapse.
If we are in fact near the crisis
stage described by Turchin and Nefedov, we will need to do something
much closer to “start over”. We need to build a new economy that will work,
rather than just “tweak” the current one. New (or radically changed)
government and financial systems will likely be needed–ones that are
much less expensive for taxpayers to fund. We are also likely to need to
cut back on basic services, including maintaining paved roads and repairing long-distance electricity transmission lines.
Because of these changes, whole new
ways of doing things will be needed. EROI analyses that have been to
date represent analyses of how our current system operates. If major
changes are needed, their indications may no longer be relevant. We
cannot simply go backward, because methods that worked in the past,
such as using draft horses and buggy whips, will no longer be available
without a long development period. We are truly facing an unprecedented
situation–one that is very hard to prepare for.