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What Is the Limiting Factor?

by Herman Daly

Herman DalyIn yesteryear’s empty world capital was the limiting factor in economic growth. But we now live in a full world.

Consider: What limits the annual fish catch — fishing boats (capital) or remaining fish in the sea (natural resources)? Clearly the latter. What limits barrels of crude oil extracted — drilling rigs and pumps (capital), or remaining accessible deposits of petroleum — or capacity of the atmosphere to absorb the CO2 from burning petroleum (both natural resources)? What limits production of cut timber — number of chain saws and lumber mills, or standing forests and their rate of growth? What limits irrigated agriculture — pumps and sprinklers, or aquifer recharge rates and river flow volumes? That should be enough to at least suggest that we live in a natural resource-constrained world, not a capital-constrained world.

Economic logic says to invest in and economize on the limiting factor. Economic logic has not changed; what has changed is the limiting factor. It is now natural resources, not capital, that we must economize on and invest in. Economists have not recognized this fundamental shift in the pattern of scarcity. Nobel Laureate in chemistry and underground economist, Frederick Soddy, predicted the shift eighty years ago. He argued that mankind ultimately lives on current sunshine, captured with the aid of plants, soil, and water. This fundamental permanent basis for life is temporarily supplemented by the release of trapped sunshine of Paleozoic summers that is being rapidly depleted to fuel what he called “the flamboyant age.” So addicted are we to this short-run subsidy that our technocrats advocate shutting out some of the incoming solar energy to make more thermal room for burning fossil fuels! These educated cretins are also busy chemically degrading the topsoil and polluting the water, while tinkering with the genetic basis of plants, all toward the purpose of maximizing short-run growth. As Wes Jackson says, agricultural plants now have genes selected by the Chicago Board of Trade, not by fitness to the ecosystem of surrounding organisms and geography.

What has kept economists from recognizing Soddy’s insight? An animus against dependence on nature, and a devotion to dominance. This basic attitude has been served by a theoretical commitment to factor substitutability and a neglect of complementarity by today’s neoclassical economists. In the absence of complementarity there can be no limiting factor — if capital and natural resources are substitutes in production then neither can be limiting — if one is in short supply you just substitute the other and continue producing. If they are complements both are necessary and the one in short supply is limiting.

Economists used to believe that capital was the limiting factor. Therefore they implicitly must have believed in complementarity between capital and natural resources back in the empty-world economy. But when resources became limiting in the new full-world economy, rather than recognizing the shift in the pattern of scarcity and the new limiting factor, they abandoned the whole idea of limiting factor by emphasizing substitutability to the exclusion of complementarity. The new reason for emphasizing capital over natural resources is the claim that capital is a near perfect substitute for resources.

William Nordhaus and James Tobin were quite explicit (“Is Growth Obsolete?,” 1972, NBER, Economic Growth, New York: Columbia University Press):

The prevailing standard model of growth assumes that there are no limits on the feasibility of expanding the supplies of nonhuman agents of production. It is basically a two-factor model in which production depends only on labor and reproducible capital. Land and resources, the third member of the classical triad, have generally been dropped… the tacit justification has been that reproducible capital is a near perfect substitute for land and other exhaustible resources.

The claim that capital is a near perfect substitute for natural resources is absurd. For one thing substitution is reversible. If capital is a near perfect substitute for resources, then resources are a near perfect substitute for capital — so why then did we ever bother to accumulate capital in the first place if nature already endowed us with a near perfect substitute?

It is not for nothing that our system is called “capitalism” rather than “natural resource-ism.” It is ideologically inconvenient for capitalism if capital is no longer the limiting factor. But that inconvenience has been met by claiming that capital is a good substitute for natural resources. Ever true to its basic animus of denying any fundamental dependence on nature, neoclassical economics saw only two alternatives — either nature is not scarce and capital is limiting, or nature’s scarcity doesn’t matter because manmade capital is a near perfect substitute for natural resources. In either case man is in control of nature, thanks to capital, and that is the main thing. Never mind that manmade capital is itself made from natural resources.

The absurdity of the claim that capital and natural resources are good substitutes has been further demonstrated by Georgescu-Roegen in his fund-flow theory of production. It recognizes that factors of production are of two qualitatively different kinds: (1) resource flows that are physically transformed into flows of product and waste; and (2) capital and labor funds, the agents or instruments of transformation that are not themselves physically embodied in the product. If one finds a machine screw or a piece of a worker’s finger in one’s can of soup, that is reason for a lawsuit, not confirmation of the metaphysical notion that capital and labor are somehow “embodied” in the product!

There are varying degrees of substitution between different natural resource flows, and between the funds of labor and capital. But the basic relation between resource flow on the one hand, and capital (or labor) fund on the other, is complementarity. Efficient cause (capital) does not substitute for material cause (resources). You can’t bake the same cake with half the ingredients no matter if you double or triple the number of cooks and ovens. Funds and flows are complements.

Further, capital is current surplus production exchanged for a lien against future production — physically it is made from natural resources. It is not easy to substitute away from natural resources when the presumed substitute is itself made from natural resources.

It is now generally recognized, even by economists, that there is far too much debt worldwide, both public and private. The reason so much debt was incurred is that we have had absurdly unrealistic expectations about the efficacy of capital to produce the real growth needed to redeem the debt that is “capital” by another name. In other words the debt that piled up in failed attempts to make wealth grow as fast as debt is evidence of the reality of limits to growth. But instead of being seen as such, it is taken as the main reason to attempt still more growth by issuing more debt, and by shifting bad debts from the balance sheet of private banks to that of the public treasury, in effect monetizing them.

The wishful thought leading to such unfounded growth expectations was the belief that by growth we would cure poverty without the need to share. As the poor got richer, the rich could get still richer! Few expected that aggregate growth itself would become uneconomic, would begin to cost us more than it was worth at the margin, making us collectively poorer, not richer. But it did. In spite of that, our economists, bankers, and politicians still have unrealistic expectations about growth. Like the losing gambler they try to get even by betting double or nothing on more growth.

Could we not take a short time-out from growth roulette to reconsider the steady-state economy? After all, the idea is deeply rooted in classical economics, as well as in physics and biology. Perpetual motion and infinite growth are not reasonable premises on which to base economic policy.

At some level many people surely know this. Why then do we keep growth as the top national priority? First, we are misled because our measure of growth, GDP, counts all “economic activity” thereby conflating costs and benefits, rather than comparing them at the margin. Second, the cumulative net benefit of past growth is a maximum at precisely the point where further growth becomes uneconomic (where declining marginal benefit equals increasing marginal cost), and past experience ceases to be a good guide to the future in this respect. Third, because even though the benefits of further growth are now less than the costs, our decision-making elites have figured out how to keep the dwindling extra benefits for themselves, while “sharing” the exploding extra costs with the poor, the future, and other species. The elite-owned media, the corporate-funded think tanks, the kept economists of high academia, and the World Bank — not to mention Gold Sacks and Wall Street — all sing hymns to growth in perfect unison, and bamboozle average citizens.

What is going to happen?

Not Production, Not Consumption, but Transformation

by Herman Daly

Herman DalyWell-established words can be misleading. In economics “production and consumption” are such common terms that it is easy to forget that they do not really mean what they literally say. Physically we do not produce anything; we just use energy to rearrange matter into a more useful form. Production really means transformation of what is already here. Likewise, consumption merely reflects the disarrangement of carefully structured materials by the wear and tear of use into a less useful form — another transformation, this time from useful product into worn out product and waste. Of course one might say that we are producing and consuming “value” or “utility”, not really physical things. However, value is always added to something physical, namely resources, by labor and capital, which are also physical things ultimately made from the same low-entropy energy and materials that go into products. Nor does the service sector escape physical dimensions — services are always rendered by something or somebody. To abstract from physical dimensions and focus only on utility is to throw out the baby and pour bathwater on the diaper.

If we were to speak of a “transformation function” rather than a production function then we would naturally have to specify what is being transformed, into what, by the agency of what? Natural resource flows are transformed into flows of goods (and wastes), by the fund agents of labor and capital. A transformation function must show both the agents of transformation (funds of labor and capital that are not themselves transformed into the product but are needed to effect the transformation), and the flow of resources that are indeed physically embodied in the flow of products, or waste. This distinction between fund and flow factors immediately reveals their complementary roles as efficient cause and material cause — any substitution between them is very limited. You cannot bake the same cake with half the flour, eggs, etc. by doubling the number of cooks and the size of the oven. One natural resource can often substitute for another, and capital can often substitute for labor or vice versa, but more labor and capital can hardly substitute for a smaller resource flow, beyond the very limited extent of sweeping up and re-using process waste such as scraps, sawdust, etc. which ought to have already been accounted for in specifying a technically efficient production function. In most textbooks the production function depicts output as a function of inputs, undifferentiated as to their fund or flow nature, and all considered fundamentally substitutable.

But if the usual production function does not distinguish fund agents of transformation from the flow of natural resources being transformed, then how does it envisage the process of converting factor inputs into product outputs? Usually by multiplying them together, as in the Cobb-Douglas and other multiplicative functions. What could be more natural linguistically than multiplying “factors” to get a “product”? But this is mathematics, not economics. There is absolutely nothing analogous to multiplication going on in what we customarily call production — there is only transformation. Try to multiply the resource flow by labor or capital to get product outflow and your “production function” will have immediately run afoul of the law of conservation of mass. Perhaps to escape such incongruities most production functions contain only labor and capital, omitting resources entirely. We can now bake our cake with only the cook and her oven, no ingredients to be transformed at all! You can multiply cooks times ovens all you want and you still won’t get a meal.

How did this nonsense come into economics? I suspect it represents a confusion between the production function as a theoretical analytical description of the physical process of transformation (a recipe), and production function as a mere statistical correlation between outputs and inputs. The latter is common in macroeconomics, the former in microeconomics, although that is not a hard and fast rule because the distinction between a theoretical description and a statistical correlation is often ignored in both areas. The statistical approach usually includes only labor and capital as factor inputs, and then discovers that these two factors “explain” only 60% of the historical change in output, leaving a 40% residual to be explained by “something else”. No problem, say the growth economists, that large residual is “obviously” a measure of technological progress. However, the statistical residual is in fact a measure of everything that is not capital and labor — including specifically the quantity and quality of resources transformed. Increased resource use gets counted in the residual and attributed to technological progress. Then that same measure of technical progress is appealed to in order to demonstrate the unimportance of resources! If we thought in terms of a transformation function, rather than production ex nihilo it would be hard to make such an error.

The basic points just made were developed more rigorously forty years ago by Nicholas Georgescu-Roegen in his fund-flow critique of the neoclassical production function. Neoclassical growth economists have never answered his critique. Why bring it up again, and what is the relevance to steady-state economics? It is worth raising the issue again precisely because it has never been answered. What kind of a science is it that can get away with ignoring a fundamental critique for forty years? It is relevant to steady-state economics because it views production as physical transformation subject to biophysical limits and the laws of thermodynamics. Also it shows that the force of resource scarcity is in the nature of a limiting factor, and not so easy to escape by substitution of capital for resources, as often claimed by neoclassical growth economists.