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The breakdown of economic expansion in the 21st century

Although the International Monetary Fund (IMF) assures us that global economic growth is proceeding apace, there are good reasons to believe that GDP numbers recording that growth exaggerate the economic expansion underway. The United States has experienced a statistical recovery in which GDP grows due to the enormous fiscal and monetary stimulus, but without creating many jobs, and despite the fact that the housing market is only a pale semblance of what it once was.

Growth in the European Union is jeopardized by the debts of several of its member countries. Japan's economy was languishing before the devastating earthquake. The emerging economies are said to be booming, but the growth numbers in China are suspect. Do newly constructed ghost cities where no one lives count? Or newly constructed ghost malls?

We have witnessed a substantial breakdown of economic expansion in the developed (OECD) economies, and there are good reasons to believe that whatever growth the emerging economies are experiencing will not last forever as many optimists predict. Does it seem plausible that China's future growth will be as vigorous and longlasting as Japan's long expansion (circa 1960-1989) after World War II?

Economic_growth_steady_as_she_goes My thesis is that global economic expansion has broken down, and where there are pockets of economic growth as in China or Brazil, it is unlikely that growth will continue for much longer. (I am thinking on decadal scales.) Clearly this is a subject for a book, whereas today I am going to outline why this thesis is credible in a blog post. It's been decades since the "Limits To Growth" crowd published their systems analysis of what might happen in the 21st century. There has been no systematic follow-up since then, yet decades have passed in which we have gained valuable experience. A number of independent researchers have investigated these problems since the 1970s. Today it's my turn.

I am going to list the primary reasons why I believe it is reasonable to expect a breakdown of human economic expansion in the 21st century. Underlying everything I say is the ultimately impossible requirement of exponential growth in economies to meet the needs of exploding human populations. But long before humankind hits a strict mathematical wall on a finite planet, things start to fall apart. That is where we stand in 2011. And now, here are the five main causes of slowing and ultimately waning economic expansion.

1. The adoption of fiat money — when the United States abandoned the gold standard, all limits on the expansion of the world's reserve currency (the dollar supply) were lifted. The debasement of the dollar has proceeded as expected. Fiat money paved the way for unlimited expansion of credit (debt). After the oil price shocks and inflation of the 1970s, this expansion made it possible for growth to occur as it had after World War II. However, the replacement of economic growth based on savings and investment by growth based on the expansion of credit was a devil's bargain. The advanced economies have now hit the limits on debt-based growth. One nasty side-effect was the financialization of everything (including commodity markets) and an astonishing expansion in derivatives of all kinds. Thus did gambling replace savings & investment. As a result, there has been an inevitable trend toward more mal-investment and unwarranted asset price inflation (bubbles). The explosive expansion of credit/debt has also created the astonishing and growing income & wealth inequality we see not only in the United States, but all over the world. I contend that such inequality stymies "real" economic growth everywhere it occurs, as opposed to growth measured by GDP. Does a feudal economy "grow" if only the landowners get richer?

2. Higher energy costs — energy imports are a tax on economies. The world has entered the era of permanently high oil prices, although there is great volatility as we've seen over the last 4 years. Despite fiat money expansion and inflation, the taxes paid by developed economies are rising in real terms, and will continue to rise over time. It is notable that most of the world's 15 largest economies, including emerging economies like China and India, are net oil importers. The relationship between oil price shocks and recessions is well-established. There are a number of reasons for the increasing scarcity of oil, and thus its rising price over time. I will not go into those reasons here. However, the classic economic theory of non-renewable resources predicts a switch to substitutes for oil which has not occurred, or has occurred unsustainably at great cost (e.g. biofuels). Thus we can expect the energy tax on growth in the world's largest economies to continue to increase.

3. Growing external costs — this is a catch-all cause of the breakdown. Name your favorite environmental or resource shortage disaster! Economists view the costs of climate change and other disasters as external costs, also known as negative externalities — "when the private calculation of benefits or costs differs from society's valuation of benefits or costs. Pollution represents an external cost because damages associated with it are borne by society as a whole [societal costs] and are not reflected in market transactions." I can not even begin to list here all the external costs being imposed upon modern societies as a result of human population and economic expansion, but consider the costs imposed by 1) anthropogenic climate change; 2) overfishing and destruction of the oceans; 3) growing freshwater shortages; and 4) various threats to future crop yields. Societies must bear these growing costs, which severely crimp economic expansion in the traditional sense. Bear in mind that we are still in the early stages of most of these disasters—we have already reached "peak wild-caught fish"—and thus external costs will rise inexorably over time. For example, consider the costs of (only) a 1 meter rise in sea level by 2100. If the big ice sheets (Greenland, West Antarctica) react to greenhouse gas forcing in an unforeseen, detrimental way, an outcome which is possible based on our evolving knowledge of their behavior, 1 meter of sea level rise could easily turn into 2 meters.

4. Faltering technological progress — the primary driver of economic expansion is technological progress. If such progress fails to materialize—to abate external costs, for example—or does not materialize at a sufficiently high "rate" to support economic growth, that growth will not occur. In recent decades, technological progress has continued in areas such as wireless communications, nanotechnology, biotech, and so forth. However, to support economic expansion, such developments must be commercial and widely deployed. While we have seen an explosion of wireless devices that make entrepreneurs like Steve Jobs wealthy, we have not seen a comparable expansion of commercial technnology in almost every other area in which research is ongoing. For example, improvements in transportation technology (plug-ins, etc.)  have been painfully slow. Ditto with energy technology. While incremental improvements happen all the time, breakthroughs, as the name implies, are rare. As things stand in the early part of the second decade of the 21st century, commercial technological progress has not been sufficiently robust to support continuing economic expansion. Sorry, Ray Kurzweil!

5. The problem of complexity — as globalized human economies expand, the complexity of the systems (e.g. fossil fuel energy extraction and distribution) required to support those economies explodes. As Joseph Tainter has noted, there are diminishing returns on such complexity, meaning you are getting less bang for the buck (a lower cost-to-benefit ratio) as systems become more complex. Unfortunately, that is not all there is to it. Human beings vastly overestimate their ability to manage risk in such systems, a subject Nassim Taleb has spent considerable time elucidating. Not only are there unintended, disastrous consequences—Black Swans!—but it is also the case that human beings vastly underestimate their own ability to subvert the complex systems they create—no system is human-proof. The financial meltdown of 2008 demonstrates all this beyond any doubt. It would be naive to expect there will be no future economic catastrophes like the ones we've seen in the last decade. Before the world became so economically interconnected and interdependent, financial blow-ups could be contained locally. Clearly, global economic expansion can not proceed apace if it is more and more frequently thrown for a loop.

I am going to leave it at that this morning. As I see it right now, these are the main causes of a breakdown of economic expansion in the 21st century. I considered adding other causes, e.g. the dangerous hubris of the United States. Much of what I've explained here may not have been well understood or foreseen when the "Limits To Growth" studies were undertaken decades ago. Readers may want to add to this list of causes, or consolidate different causes, or expand on certain causes. I have stuck to a high level of generality here, and the causes of the breakdown interact in myriad ways.

My apologies to all those who have also thought about these problems for many years now. I thought I'd throw my two cents in, having also thought about these problems on and off for a long time. In fact, I have lived long enough to watch the disaster unfold, which is not an outcome I expected.

Unless humankind engages with what appear to be clear limitations on its economic prospects in the 21st century, we will be completely unprepared for the chaos to come. Lack of preparation is the outcome I expect.

What do you think? Leave a comment below.

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