by Brent Blackwelder

This March, at the Environmental Film Festival in Washington, DC, I saw a documentary on the destruction of the Aral Sea in Kazakhstan, once the world’s fourth-largest inland lake. Soviet planners and decision makers fifty years ago decided to divert the two main tributary rivers of the Aral to grow cotton. Starved of fresh water inflows, the Aral Sea has shrunk to half its original surface area and lost 75% of its volume.

The productive fishery was wiped out, salinity levels in the lake tripled, and the water has been poisoned with pesticides. I wondered what kind of deceptive economic calculations were used to justify destroying one of the natural wonders of the world.

I recently argued that today’s global marketplace is characterized by cheater economics — a corporate welfare system that has no part in a sustainable, steady state economy. There’s another type of economics that’s also in wide use today. It’s not quite as “in-your-face” as cheater economics, but it’s just as harmful because of the way it distorts reality. Deceptionomics uses “fool-you” accounting to omit genuine costs and misrepresent the true benefits and costs of economic transactions.

Robert Trivers’s new book The Folly of Fools examines the role of self-deception in human life. The animal kingdom is full of examples of deception by both predator and prey. For example, over 100 varieties of insects look like innocent twigs but consume other types of insects that unsuspectingly come close. Trivers applies his analysis of self-deception to the economics profession. Economics, he contends, is not yet a science because it fails to ground itself in underlying knowledge, namely biology. He writes:

…when a science is a pretend science rather than the real thing, it falls into sloppy and biased systems for evaluating the truth… [M]odels of economic activity must inevitably be based on some notion of what an individual organism is up to. What are we trying to maximize?

Here economists play a shell game, he notes, as they tell us that people attempt to maximize “utility.” However, when asked what constitutes utility, they reply, “Anything people wish to maximize.” How’s that for circular logic? Sometimes a person will try to maximize income, sometimes food, and sometimes sex over both food and income. So now we need “preference functions” to sort out all the competing preferences in an attempt to maximize utility, but, as Trivers points out, “economics by itself can provide no theory for how the organism is expected to rank these variables.”

Another big mistake by economists is the conflation of two senses of utility — the utility of your actions to yourself, and the utility of your actions to others. Most economists view these two kinds of utility as being aligned. Trivers says that economists “often argue that individuals acting for personal utility will tend to benefit the group.” Thus, they “tend to be blind to the possibility that unrestrained pursuit of personal utility can have disastrous effects on group benefit.” Trivers observes that economists assume (contrary to direct experience and biological evidence) that “market forces will naturally constrain the cost of deception in social and economic systems.” He notes with astonishment that “such is the detachment of this ‘science’ from reality that these contradictions arouse notice only when the entire world is hurtling into an economic depression based on corporate greed wedded to false economic theory.”

In a steady state economy, we would seek to minimize deceptive practices. We would not delude ourselves with the ruse that GDP captures the essence of well-being. Nor would we have separate moralities for business and community. We teach our kids not to squander their allowance and to save some for the future. In family and community settings, people care about the long term and consider what kind of world our children and grandchildren will live in. But in business circles, all attention is riveted on quarterly returns. Economists employ a discount rate in their calculations that values the future 100 years from now as being worth almost nothing.

The truly deceptive nature of our current economic system can be seen by looking at the big debate over oil prices and the attempt to blame President Obama for the high price of gasoline. Meanwhile candidate Newt Gingrich proclaims on national TV that he has a plan for $2.50-a-gallon gasoline. But even at $4.00 per gallon, the price of gasoline is deceptively low.

Every day the U.S. is spending approximately $2 billion buying gasoline. What is remarkable and not disclosed to the public, writes Amory Lovins in his new article in Foreign Affairs, is the $4 billion in losses stemming “from the macroeconomic costs of oil dependence, the microeconomic costs of oil price volatility, and the cost of having our military forces ready for intervention in the Persian Gulf.”

The International Center for Technology Assessment reported in 2001 on the deception involved in the price of gasoline. It found that the real cost of gasoline, when the crucial indirect or hidden costs are included, was between $9 and $15 higher than the price paid at the pump.

Such estimates rarely appear in the mainstream media. As a result, many people are unaware of the high environmental and social costs of our economic transactions. Even if we remain unaware of these costs, we still have to pay for them. We’d be better off eliminating the deception embedded in our institutions and making economic decisions based on knowledge of true costs including the environmental impacts of growth. As long as deceptionomics rules, fuzzy math will be used to justify incessant GDP growth, and one by one we must say goodbye to the Aral Seas of the world.

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.