What Is the Limiting Factor?
By Herman Daly
In yesteryear’s empty world, capital was the limiting factor in economic growth. But we now live in a full world.
The number of standing forests and their rate of growth limit the production of cut timber because we live in a resource-constrained world. (Image: CC0, Credit: Russell Lee).
Consider this: 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 the 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 80 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:
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.[1]
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.
In capitalism, capital acts as the limiting factor rather than natural resources. Neoclassical economics denies the dependence on nature. (Image: CC0, Credit: Jan-Mallander).
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, there is a reason for a lawsuit, not a 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 and 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?
[1] Nordhaus, W, and J. Tobin. 1972. Economic research: retrospect and prospect. Economic Growth 5:1-80.
Herman Daly is CASSE Chief Economist, Professor Emeritus (University of Maryland), and past World Bank senior economist.
Real Life Economy
Scrap the concept of capital and replace it with the concept of available resources. These are any form of usable order of space, time and energy, such as natural resources, information, or gene expression in biomass.
Scrap the concept of labor and replace it with the efforts (work) of living beings to compete for these resources.
The increase of thermodynamic entropy naturally depreciates all resources making them scarcer.
The growth of life binds energy locally and temporarily decreasing thermodynamic entropy or slowing down its increase, thereby producing (or renewing) resources, but also producing more competition in the function of the living organism that grows.
Reusable waste of living organisms (including their biomass after death) increases the available resources without increasing competition; whereas unusable waste decreases the available resources (not unlike entropy).
If the unit of measure of competition (work) is defined as fixed, such as the Joule, then it cannot be devaluated. Joule is the unit of exchange of energy.
In a scientific economy, based on these natural principles, inflation could only be caused by more competition over scarcer resources. The growth of life and the increase of thermodynamic entropy must cause natural inflation, producing more effective ways of using the available resources. This manifests as biodiversity.
We already had a better economic paradigm: It was biodiversity. As usual, we tried to reinvent the wheel with the results that we all know.
What is going to happen is that we will continue trying to replace biodiversity with our poor man’s substitute, fail epically, and destroy millions of years worth evolution possibly including our civilization. On the bright side, the remaining biodiversity could be better resistant against political economics should it ever evolve again.
Herman,
I liked your second paragraph very much. It brought clearly into focus the basic truths which are so often overlooked. The rest of your piece gave a clear picture of the problems we are up against.
As to the future; for the last two hundred and fifty years economic growth has enjoyed a very good press, and in fairness it has brought some of us considerable benefits. Trying to promote the idea of a zero growth economy will be an uphill struggle until we have a successful example to cite.
Our best hope is probably with one or two of the smaller democracies, particularly those with proportional representation. I am thinking of some of the Scandinavian countries who are already pretty left wing, or perhaps New Zealand where they economy is largely agricultural. My own country of Scotland does have proportional representation and although it is not completely independent we have a fair bit of autonomy in certain areas and that may improve soon. Unfortunately although we are generally left wing in our outlook, the Green Party who might have supported a move to zero growth seem to have lost their way and now only have one seat in Parliament. The present government does have a strong commitment to developing alternative energy but that is still linked to economic growth.
Small countries like Scotland or New Zealand will have little impact on total world consumption of course but if they could model successful economies based on zero growth then, when the world eventually realizes it has to act there would be a blueprint they can use and adapt to their own situations. This would also give campaigning groups in these countries a lever to prise the advocates of continued growth out of their ivory towers.
One of the big misconceptions swirling around the economics world concerns the term “productivity”. It’s never satisfactorily defined in economics, simply because it couldn’t be incorporated into conventional economic theory.
Since everything relies on energy (without it everything would stop and drop to minus 270 degrees C), then clearly the laws of thermodynamics should play a somewhat important role in economic productivity…
And those laws say that energy can be neither produced nor consumed, so therefore any reference to the term economic “productivity” will be at best confusing, and at worst grossly misleading.
Since only plants can produce, and animals only consume, then really our economic “productivity” is zero.
Energy can be broken down into two types for analyzing economies — firstly, the “technical” energy that powers the mechanics of our economy, and secondly the “biological” energy which is the food that powers our bodies. Since all food is produced by plants, and since over 80-90% of the energy that drives the mechanics of our economies was also produced by plants (millions of years ago in the form of fossil fuels), then clearly our economies are still almost completely dependent on photosynthetic net primary production. What economic “productivity” entails is the transfer of net primary production over to our use — and all the economic arguments out there basically boil down to the amount, efficiency, and equitable distribution of that production.
We are animals fully dependent on our ecosystems, even in our modern economies. We are bound by the trophic pyramid.
What I find interesting is the comparison of our arguably free market economies (at least, in respect to natural resources consumption) with natural animal population dynamics (arguably, the best example of free market economics we could get). We inevitably see that IF a population of animals is provided with additional sources of net primary production, it WILL grow to take advantage of this. It will grow until it has filled up that opportunity, and then its growth will stop, either through disease outbreaks, overpopulation and crashes, or most preferably, predation which keeps the population in steady check.
Well, since we are no different than any of those animal populations, then you can bet that ALL sources of NPP will be used by us before we’re done (anyone care to bet whether ANWR will stay locked up once all the US’s other oil gets used up?)
Since human population growth could theoretically stabilize to replacement level based on demographics alone, it is tempting to think that we will achieve steady state naturally. However, there are a lot of poor people in the world and they all want a western standard of living, so our ecological footprint would skyrocket. Since we have developed so much of our species’ extent around overshoot based on fossil fuels, then without some miraculous emergence of new solar energy infrastructure (which seems unlikely but that’s another discussion), then all of this leveraged demand will once again fall onto existing ecosystems as the ancient ecosystems get burned up. We will be doomed to repeat the population dynamic of any other animal in overshoot.
“What is going to happen?”
Nothing good I’m afraid.
“What is going to happen?”
We will run headlong into the walls of what I call the Devils Triangle. At the apex is an already excessive and unsustainable population level which is growing at an exponential rate.
At one bottom corner is environmental destruction and devastation,including climate change.
At the remaining corner is energy.
These problems can be solved but first they have to be recognized and then recognized as urgent.Then comes the more difficult process of changing our mindset and our expectations.
Wonderful article but at least in my mind the two are practically indstinguishable. The proponents of eternal growth maintain that we will always have tehnology to pull us out of resource limitations, andf they can point to some examples such as the Green Revolution and the recent ability to use low-EROEI fuels such as tar sands and “fracked” oil and natural gas. The faith that techology will circumvent physical resource limits is only as well-founded as the faith that capital will be available to develop the technology, and it has become clear in recent years that this is a fallacy. Example 1: The FAO in its 22010 report on food supplies for the next decade hypothesized that petrioleum prices would not exceed $90/barrel (essentially an overoptimistic estimate of resource-availability) AND that crash investments in technological development would push upward the annual grain-yield increase (which has sate at 1%/yr ever since the mid-seventies and therefopre falls ehind population growth). The first is an overestimate of resource availability while the second is an overestimate of capital availability. Example 2. The mainline environmentalists have placed their faith in the rapid technological development of sustainable altrnative energy sources, but the capital has been missing for the necessary investments. Example 3. There has long been faith that medical advances in antibiotics would continue to proceed more rapidly than bacterial advancements in ovrcoming antibiotics. That is no longer true and the pharmaceutical industry is throwing in the towel not for lack of ability but for lack of capital. In each of these examples, the lack of capital adequate for technological advancement could accurately be attributed to tightr resources.
2012 is going to be known as the year that the global economy crashed because of SIMUILTANEOOUS collapsing capital and collapsing natural resources. The European and US economies re both going kaput because of the debt crisis and peak oil happening at the same time, AND THEY ARE THE SAME THING, eg the Europens can’t handle cuts in government programs at the same time as gas prices are careening upward, and the US has40 million unwanted Mcmansdions preventing recovery of the housing market, which are unwanted because in part because they are unaffordable price-wise when the people don’t have jobs and have too much tied up in paying for oil, and are unaffordable resoyurce-wise because they are the housing equivalent of the SUV. Additionally, of course, available jobs are dropping because petroleum supply and demand are both dropping at 4.5%/yr in the US (Petroleum Economist Magazine 4/26, “Where Are the Missing Barrels?”)
The United States over most of its history has been blessed with readily-available capital, largely attributable to what Frederick Jackson Turner realistically called “free land” – the land the US government took by brute force from the Native Americans and Mexicans and then handed out like candy to settlers and corporations. It is impossible to distinguish “free land” from “free capital” in this case, so saying we grew rapidly because of availability of natural reesources or because of availability of capital is the same thing. Isn’t it always thus?
Interesting read. Research on management strategies and best resource use could put this ,”The Sky is Falling” theory on the back burner,
The logical arguments employed by Soddy, Georgescu-Roegen & Daly has been routinely ignored by mainstream economists. A tragic waste both of their respective talents and of the time our society could have spent by heeding these warnings.
The recent work of Ayres & Warr is as close to the perfect “proof” of the critical role of energy:
http://en.wikipedia.org/wiki/Useful_work_growth_theory
They have played the economists at their own game, using their own methods. Let’s hope that this proof is ignored no longer.
Herman,
In re reading the original text I was suddenly truck by your comment about the belief that growth would cure poverty without the need to share. If we could ever achieve a stable economy world wide, we ourselves would then be faced with this prospect. Would we be prepared to share our wealth with the two thirds of the world who live on the bread line. A sobering thought.
I’ll end with this short quote from our national poet. It wont cheer you up but it can be useful to throw at politicians who only look to the next election.
The last verse of Robert Burns To a Mouse
‘
‘Thou art blest compared to me
the present only toucheth thee
while I look back with jaundiced ee on prospect drear
and forward tho I cannot see with dread and fear
All eloquently written but I also hold this sentence the most valuable one ‘The wishful thought leading to such unfounded growth expectations was the belief that by growth we would cure poverty without the need to share.’ Not sharing and caring is the root cause and we will either be doomed or simply repeat our errors, (one way or another), unless this fundamental cause it dealt with. Economics fails to do so even when discussing how we must change!