Days of Cheap Energy-Fueled Innovation Coming to an End

Months into a long overdue exploration of energy prices, few seem to mention issues related to the long history of affordable oil and capital, labor substitution. The age of oil has been a period of rapid and rapidly rising production of goods, services and wealth. The ability to harness technology-driven productivity and output enhancement has transformed the world in wave after wave. The vast quantities of wealth produced and the enormous increases in human population, food output, longevity, literacy and health all attest to this. Abundant and price competitive energy was substituted for human physical labor in industry after industry, nation after nation.

The very success and extent of this process has created the demand increase partially driving oil, coal and natural gas prices today. There are implications for the relations between capital and labor, wages and profits. Abundant, reliable and cost competitive new technologies must be run on abundant, reliable and cost competitive energy inputs. The length and scale of present energy price increases threatens to begin to alter the profitability and desirability of marginal production processes already. Most commentators don't focus on substitution between capital and labor in the face of energy price increases. The longer prices stay high, and the higher they go, the more important this area is to explore.

Skill biased technical change and globalization have influenced the split between wages and profits. Rising productivity has created the possibility of rising wages and profits. Sometimes this possibility becomes reality, sometimes it does not. Lately, in the US and abroad, the gains to productivity have gone more toward profits than wages. This makes clear that abundant, reliable and affordable energy has allowed greater wealth to be produced and a greater share of that greater wealth has been captured by profits. Rising energy prices could pressure this in two ways.

Energy prices are, directly or indirectly, input costs into most goods and services production. Sustained and significant energy cost increases eventually become higher food and living costs. We are already at least nine months into a significant acceleration in expected energy and food price increases. If wages don't rise, an increasing portion of incomes will be redistributed to food, energy and costs related to food and energy. This will act like a wage reduction to the extent that it is difficult for consumers to find suitable and stable priced substitutes for food and energy. Systematic wage increase demands can not be held off indefinitely. Rising unemployment may reduce demands but, costs of living apply persistent and acute pressure.

Meanwhile, firm costs of inputs are pressured up by rising prices and increasingly strained basic operational planning and design born of assumption about cheap, reliable energy and labor. Past imbalances between profit and wage gains from productivity are likely to increase demands for wage hikes. Further massive substitution of technology for labor will be more difficult as consumers struggle under high food and energy costs as firm costs rise.

Production processes with significant energy and labor cost components should be expected to be hit hardest and first. Here we might take airlines as the canary in the coal mine. We might also look hard at a Chinese economic model that relies on abundant, inexpensive labor and energy with a voracious appetite for distance shipped raw materials and final products.

The long term massive substitution of technology-driven innovation, fueled with cheap wages and energy, may be at increasing risk. Rising energy costs are hard to substitute around. Labor is an obvious substitute in relatively few cases. That may change on the margin. More broadly, high and rising energy prices may begin to pressure the divisions between wages and profits through direct business costs and wage demands.

The last three decades in America have been defined by rapid technological change, profit biased output growth and generally cheap and abundant energy. Clearly, the world will not change overnight and energy prices have not attained - nor will they likely in the near future attain levels - sufficient to decimate major structural pillars of modern economies. It may be getting toward a point where we entertain discussion of the implications of energy prices for inflation, wage rates and profits on a macroeconomic level.

Disclosure: None

Comments

[PrudentMan, CFA]

This is very positive: the end of the Western World's dependence on energy from the disruptive Middle East. The world will be a better place.

The Western Culture, with its propensity to adapt and overcome adversity, is well known, though most pessimistic losers in Congress and the media don't get it.

When the automobile came on the scene the buggy whip producers and salesmen who were on the ball switched to producing goods and services for a new industry.

We have a new expanding industry and certainly American Ingenuity will prosperous while the loser look for political protection of their inefficient products.

This is Free Enterprise. A lot of Capitalist, a term coined by Karl Marx, will never catch on and go out of business. This is truly constructive destruction.

[My-2-Cents]

Agreed. We are just in time to witness this paradigm-shift first hand...lucky us. The writing is on the wall and the Airlines are probably just one of many “canaries” in the proverbial coal mine. Will they be sacrificed? Good question...some real consolidation is going to be required...but that’s just conjecture. It's clear we need to achieve MORE WITH LESS across several critical industries: farming, commodities ...you know everything people need to survive and thrive.

Bottom line, efficiencies must be achieved with solar/wind/& bio-fuels...hopefully more, liquid coal perhaps. It’s our manifest destiny that our R&D be redirected TODAY, so that we have real energy options in our future. There is no need to end our dependence on oil tomorrow (although in 50 years the combustion engine will be more at home in a museum)...but we need to reverse the current trend and finally start to reverse our increasing dependence on oil, foreign or otherwise.

In twenty years time, once progress and innovation has a chance to increase exponentially, perhaps we’ll look back on this with some grand perspective (i.e.without the CRISIS mentality). But the real challenge here—here it is; HOW do we survive economically as a nation until then? JOB TRAINING? Several labor markets are approaching their respective water-shed moments and such transitions are always difficult and complex. On industries, companies and families trying to survive...I don’t know what the lesson is here...I guess it’s our finally coming to the realization that currently our ENERGY options are SEVERLY limited, along with our future economic expansion and progress.

[jarco]

But, whose to fault for this? Our/your government is supposed to impose some form of management and appears totally on the side lines


On Jul 02 10:36 AM My-2-Cents wrote:

> Agreed. We are just in time to witness this paradigm-shift first
> hand...lucky us. The writing is on the wall and the Airlines are
> probably just one of many “canaries” in the proverbial coal mine.
> Will they be sacrificed? Good question...some real consolidation
> is going to be required...but that’s just conjecture. It's clear
> we need to achieve MORE WITH LESS across several critical industries:
> farming, commodities ...you know everything people need to survive
> and thrive.
>
> Bottom line, efficiencies must be achieved with solar/wind/& bio-fuels...hopefully
> more, liquid coal perhaps. It’s our manifest destiny that our R&D
> be redirected TODAY, so that we have real energy options in our future.
> There is no need to end our dependence on oil tomorrow (although
> in 50 years the combustion engine will be more at home in a museum)...but
> we need to reverse the current trend and finally start to reverse
> our increasing dependence on oil, foreign or otherwise.
>
> In twenty years time, once progress and innovation has a chance to
> increase exponentially, perhaps we’ll look back on this with some
> grand perspective (i.e.without the CRISIS mentality). But the real
> challenge here—here it is; HOW do we survive economically as a nation
> until then? JOB TRAINING? Several labor markets are approaching their
> respective water-shed moments and such transitions are always difficult
> and complex. On industries, companies and families trying to survive...I
> don’t know what the lesson is here...I guess it’s our finally coming
> to the realization that currently our ENERGY options are SEVERLY
> limited, along with our future economic expansion and progress.<br/>

[iThinkBig]

If we take the 10,000 foot view, Jarco is correct. It is not that we can't innovate to save our current culture in time. It's that big government has become an oligarchy with a current ability as an empire to ignore it's constituents in pursuit of it's own interests of power and greed. Alexander Hamilton, the first Treasurer of the U.S. warned that when banks and government collude, Americans will become homeless and penniless. Such has occured before many times, always with bad results but the great depression and our current difficulties come readily to mind. We're already breaking records of the great depression but Washington (besides the Prez) is doing next to NOTHING. 49% of our GDP, small business and consumers are being preyed on by government and utilities. The megacorporations have hedges but will also go down with Main St.

If we want to survive as a nation we had best understand how to fund public servants outside of the RNC or DNC money machines of lobbyists whom have bought and paid for a politician before they even step into office.

I know many bright guys who feel making $130k a year is great money, would love to have three months off a year and feel ready to serve our nation on behalf of there families and loved ones. Problem is, the majority can't simply take a year off from work to run a campaign never mind the money it takes to advertise. Sacrifice by those of us with money is going to need to occur. I am running for Congress in 2012 and giving time to the Administration now on economics and energy, about all I can do to serve but time is money.

[akapital9]

Great comments.

I agree that ultimately the end of the oil era presents tremendous opportunities and innovation for true free market capitalism - but alas we don't live in a true free market. We live in an oligarchy controled by interests of big oil.

We could have addressed this proactively years ago but such action is rare in human history.

Unfortunately, this is a dynamic of the human situation. Most humans don't do anything about obesity or cancer until they are faced with dire circumstances...the disease is like a pregnancy (to paraphrase Nietzsche). Our economy is in a similar situation. Like others I am hopeful that innovation can overcome tradition.

[Cicero]

I Think, were you one of the speakers at the Freedom Rally in DC back in April? Ron Paul really needs some support in Congress - he's been holdng down the fort for decades.

[cal48koho]

This an important article which posits ideas that are not dogma in the mainstream economic community. It is worth a reread and a clip and save. If he is correct the conclusions are sobering.