Closed Economy
by Chetan Parikh
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In a wonderful book Economyths”, the author, David Orrell, speaks about the mimeasurement of economic growth and the resources needed to sustain that growth.


“People have been worried about ‘peak oil' for almost as long as we have been pumping it out of the ground. However, the fact that past predictions of supply exhaustion have been wrong does not inoculate us from it ever happening at all. It seems reasonable to suppose that we are approaching the later stages of our long relationship with carbon fuels; and as Jevons knew, our energy supplies are vital for our long-term future.Weirdly,though, mainstream economic theory has almost as little to say about oil as it does about fish, or bees, or anything outside the human sphere. That is one reason why prices for these things don't reflect their real worth. And it is also what supports the myth that the economy can grow for ever.


Neoclassical economics represents a mathematical model of human behavior. As the systems scientist John D. Sterman observes: 'The most important assumptions of a model are not in the equations, but what's not in them; not in the documenta­tion, but unstated; not in the variables on the computer screen, but in the blank spaces around them. One of the things miss­ing from neoclassical economics - and it's a big one - is the rest of the planet. It completely neglects the fact that the human economy is embedded in the biosphere, which consists of living things (including bees and wheat), the products of living things (including honey and oil), and necessary resources for living things (like fresh water).


Traditionally, economists had recognised three factors of production -land, labour, and capital. In neoclassical econom­ics, though, only labour and capital have played an important role. Natural resources were either excluded from the list or paid lip-service to. In 1974, one 'laureate' economist even said that 'The world can, in effect, get along without natural resources' because human ingenuity and technology can always provide a substitute. Jevons' concerns about exponential growth in a world with limits were lost in the mix.


When natural resources were considered, they were assumed be essentially infinite. 'Minerals are inexhaustible and will never be depleted: wrote energy economist Morris Adelman in 1993. 'A stream of investment creates additions to proved reserves, a very large in -ground inventory, constantly renewed as it is extracted. ... How much was in the ground at the start and how much will be left at the end are unknown and irrelevant. Even in Mankiw's current textbook Principles of Economics, as Gilles Raveaud points out, natural resources and energy are left out of the chapter on economic growth. As a result, 'they cannot become a problem - for economists, that is.’


It is as if economics has become so disembodied and detached from reality that it thinks it can do without the physi­cal world.


The reason for this peculiar attitude is rooted in the idea, derived from the work of Jevons et al., that the economy is a beautifully tuned machine - a closed system that operates according to perfectly calibrated laws. The machine will of course need fuel to keep it running, and oil to keep it lubricated, but these are freely available on the open market from a range of suppliers. The stock of these things in the ground is of no more concern to an economist than the stock of fuel is to the owner of a Lamborghini. They just know it's there.


Within this closed economic system, according to theory, the 'law of supply and demand' correctly allocates resources to each of the machine's parts. However, while this 'law' may be of some fuzzy use within the human economy, it breaks down completely at the boundaries of our economy with the natural world. The economy has no way to measure exactly how many fish are in the sea, or how much oil is in the ground. The costs of supply measure only the costs of extraction, which depend on a large number of factors, and do not smoothly adjust to give a measure of scarcity. Fishermen did not stop fishing the Grand Banks because it was too expensive- they stopped because one year there were no fish.


In fact, as Daly noted: 'resource prices are to a large extent arbitrary - a fact that is seldom recognized.' The supposedly sensitive price signals of the free market turn out to be not just mildly paradoxical in their behaviour, but completely distorted. A good illustration is provided by the price perambulations in the commodities market in 2008”.