Monday, September 03, 2012

Malthusian Doomers Appear Totally Ignorant of Basic Economics

Two recent articles in the economic blogosphere point out the basic ignorance in economics of Malthusian doomers:
The neo-Malthusian extrapolation in doom-laden pieces like “Welcome to Dystopia” never ceases to amaze me (I sometimes think such articles can be best understood by applying psychology rather than economics. Most – including Grantham’s latest – could be productively revised through the author asking themselves the simple question: ”Why is the lamp by which I am writing this not lit by whale oil?”).

For starters, Grantham has never heard the warning of a former a British Chancellor of the Exchequer, “Beware of extrapolation: it can make you go blind” (even though he quotes Kenneth Boulding to the same effect at the start of the article). Again and again, Grantham holds one item constant, and draws a straight line to chaos, doom, starvation and war.

Like many business leaders today, Grantham is also not afraid to release his Inner Authoritarian, writing that the only people who seem to understand what is going to happen to future commodity prices (Up! Up! Up!) and the world economy (Down! Down! Down! – though how that squares with Up! Up! Up! is not explained), are the Chinese Government and the military forces of the US and UK. I know that fear sells, and this is an investment newsletter, but Wow! – for a man who’s made millions, Grantham sure lacks faith in the price mechanism. (Grantham also fails to recognize the limits of developmental autocracy in China, but he’s hardly alone there).

Truly, “Welcome to Dystopia” is a catalog of self-contradiction and error. Like many “The world is running out of X” pieces, Grantham cites Leading Authorities about dwindling supplies of various essential commodities, and paints dire straight lines between present trends and doom. He fails to explain convincingly, however, why this time innovation, spurred by price, won’t drive substitutes and solutions. Hasn’t he heard of the Simon and Ehrlich bet? Oh. I forgot: ”This time is different”. I suppose he gives fair warning by using the terms “paradigm shift” and “phase change” right off the bat.

As close friend pointed out to me a few years ago, “When you buy commodities, you’re selling human ingenuity.” I may not be as wildly optimistic as some, but I certainly don’t think Grantham makes a persuasive – or even logically consistent – case for a coming commodity dystopia. _Strategy, Surprise, and Disruption
Much more with informative price trend graphics at the link above. The concept of the "price signal," and the effect it has on future behaviour of people in the marketplace appears to have escaped most doomers.

Interestingly, the author of the piece above has challenged doomer Jeremy Grantham to a 10 year bet on future trends in commodities prices, a la the famous Julian Simon : Paul Ehrlich wager. Another article pointing out the lack of economic savvy among doomers looks specifically at peak oil doomerism:
Every few years, another author comes out and says that we just reached peak oil and should begin preparing for the onslaught that will be starting to occur -- then, of course, it doesn't occur, mostly for the following 3 reasons.

Problem 1: Innovation Changes Economically Recoverable Oil Supply

When economists begin formulating theories, they often make one of the most critical mistakes possible -- something, thankfully, the Austrian school doesn't do. They begin assuming that economics involves static numbers.

George Soros's theory of reflexivity is probably one of the most important concepts investors should learn to understand. It's the notion that people react to people and change their actions, and the other people react to the changes, creating an endless feedback loop.

This feedback loop is why it's impossible to assume that trends are constant when they are about society. This includes economics, innovation, demand for certain goods and services, and other things.

Peak oil might make sense if we were stuck with a set amount of oil, people were not going to begin shifting away from oil consumption 'in time', if innovation didn't exist, and if economically unrecoverable oil couldn't become recoverable with higher prices.

Of course, all of the above aren't true. In fact, this is one reason researchers at Harvard are making the opposite predictions of the oil-peakers.

From Harvard's Kennedy School website on June 26th:

"Oil production capacity is surging in the United States and several other countries at such a fast pace that global oil output capacity is likely to grow by nearly 20 percent by 2020, which could prompt a plunge or even a collapse in oil prices, according to a new study by a researcher at the Harvard Kennedy School...

Contrary to some predictions that world oil production has peaked or will soon do so, Maugeri projects that output should grow from the current 93 million barrels per day to 110 million barrels per day by 2020, the biggest jump in any decade since the 1980s. What's more, this increase represents less than 40 percent of the new oil production under development globally: more than 60 percent of the new production will likely reach the market after 2020."

Far from reaching peak oil and seeing prices increase forever, we're seeing a very real possibility of the opposite. Innovation exists. Oil supply can increase. Not forever, of course, but certainly long enough for society to transition to another energy source altogether, like electric or something else.

Companies like Exxon (XOM), Chevron (CVX), and BP (BP) are dedicating huge amounts of money to make sure that innovation and exploration get better every year -- not static.

Problem 2: Higher Prices Change Economically Recoverable Oil Supply

Innovation makes some oil sources economically recoverable that used to not be recoverable. For example, according to the Economist last year, we were seeing demand outstrip supply. But that doesn't mean we were seeing peak oil. Even with increased demand, we were seeing a boost in production.

When demand begins to outstrip supply, this has an important impact on the market. It makes some oil that wasn't economically recoverable suddenly more recoverable because of the higher prices.

Just look at shale oil. As prices begin to increase, as well as technology, more and more oil is suddenly recoverable and can be put on the market. Apparently, supply and demand still work.

Problem 3: Higher Prices Automatically Cut Demand For Oil Products

This is probably the most important concept we need to understand. Higher oil prices make non-oil based fuels more economical. This means electric cars or something else entirely. We're decades away from even needing electric cars, but if there are long-term trends of oil price growth, then we'll see people transition to fuels that are cheaper. It's the way the market works.

This is one reason having higher fuel standards on cars actually is an economically destructive thing, because higher gas bills for consumers can end up pushing billions toward developing new fuels, allowing us to move to more economically friendly fuels decades earlier than with higher fuel standards.

Once again, government action misses the point of "higher prices" in the first place. Governments often miss the fact that ignoring prices with policy is economically destructive. _Shaun Connell
The author of the second piece above likewise points out the importance of the "price signal" in changing economic behaviour.

If a person cannot even comprehend the most basic concepts of economics and economic behaviour, their prognostications about the future are unlikely to reflect what will actually occur.

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