PU Peak Oil Conference, Washington, DC
DA May 9, 2006

HD The Steady-State Economy and Peak Oil

AU By Herman E. Daly*

*School of Public Policy University of Maryland

In classical economics (Smith, Malthus, Ricardo, Mill) the steady-
state, or as they called it the "stationary state" economy was a real
condition toward which the economy was tending as increasing
population, diminishing returns, and increasing land rents squeezed
profits to zero. Population would be held constant by subsistence
wages and a high death rate. Capital stock would be held constant by a
lack of inducement to invest resulting from zero profits thanks to
rent absorbing the entire surplus which was itself limited by
diminishing returns. Not a happy future -- something to be postponed
for as long as possible in the opinion of most classical economists.
Mill, however, saw it differently. Population must indeed stabilize,
but that could be attained by Malthus' preventive checks (lowering the
birth rate) rather than the positive checks (high death rate). A
constant capital stock is not static, but continuously renewed by
depreciation and replacement, opening the way for continual technical
and qualitative improvement in the physically non growing capital
stock. By limiting the birth rate, and by technical improvement in the
constant capital stock, a surplus above subsistence could be
maintained and equitably distributed. The stationary state economy
would not have to continually expand into the biosphere and therefore
could leave most of the world in its natural state. The stationary
state is both necessary and desirable, but neither static nor eternal
-- it is a system in dynamic equilibrium with its containing,
sustaining, and entropic biosphere. The path of progress would shift
from bigger and more, towards better and longer-lived.

In the late 1800's classical economics was replaced by neoclassical
economics, and although the term "stationary or steady-state economy"
was retained, its meaning was radically changed. It no longer referred
to constant population and stock of capital, but to a situation of
constant tastes and technology. In Mill's conception physical
magnitudes (population and capital) were constant, and culture (tastes
and technology) adapted. In the new version culture (tastes and
technology) are constant and the physical magnitudes (population and
capital stock) adapt. Given that our cultural tastes were assumed to
reflect infinite wants, and that technical progress was considered
unlimited, the way to adapt was by growth, so-called "steady-state
growth" which means proportional growth of population and capital
stock. The absolute magnitudes continue to grow while the ratio
between them is supposed to remain constant. Furthermore the concept
of a steady-state is no longer thought of as a real state of the
world, whether desirable or undesirable, but as an analytical fiction,
like an ideal gas or frictionless machine. It is a useful reference
point for analyzing growth, and has neither normative nor ontological
significance, whereas for Mill it had both. Mill's steady state was
both necessary in the long run and desirable much sooner. It is not
too much of an oversimplification to say that in a sense the classical
economists were concerned with adapting the economy to the dictates of
physical reality, while the neoclassicals want to adapt physical
reality to the dictates of the economy. In an empty world the dictates
of physical reality are not immediately binding on growth; in a full
world they are. Consequently, and paradoxically, it is the older
classical view of the steady-state, Mill's version, that is more
relevant today, even though the neoclassical view dominates the
thinking of empty-world economists.

Another basis for the stationary state comes from the demographers'
model of a stationary population, one in which birth rates and death
rates are equal and both the total population size and its age
structure are constant. This model is both an analytical fiction and
also for some a normative goal. Indeed, a constant population is part
of the classical view of the stationary state. A constant population
requires only that the birth rate equals the death rate, and that
could be the case at either high or low levels. Most of us prefer
lower levels, within limits, because we value longevity. Likewise, the
constancy of the capital stock requires production rates equal to
depreciation rates. Basically the preference here is also for equality
at low rather than high levels. Greater life expectancy of capital
(the total stock of durable goods) requires less depletion and
pollution (lower rates of throughput). In this view new production is
a maintenance cost of a capital stock that unfortunately depreciates
as it is used to serve our needs. Like other costs it should be
minimized, even though the idea of minimizing the flow of new
production is strange to most economists.

Something similar to the classical stationary state was revived by
Keynes in his concept of the "quasi stationary community". This was
also a real state of the world rather than an analytical fiction, and
was considered desirable by Keynes. It assumed population stability,
no wars, and a couple of generations of full employment and capital
accumulation. Keynes believed that in the resulting world of abundant
capital the "marginal efficiency of capital" would fall to zero,
leading to a situation in which new investment would merely replace
capital depreciation and the capital stock would cease growing.
Capital would in effect no longer be scarce leading to a near zero
interest rate and the happy consequence that it would no longer be
possible to live off of accumulated wealth -- the "euthanasia of the
rentier." As Keynes put it, "The owner of capital can obtain an
interest rate because capital is scarce, just as the owner of land can
obtain rent because land is scarce. But whilst there may be intrinsic
reasons for the scarcity of land, there are no intrinsic reasons for
the scarcity of capital" (General Theory..., p. 376, 1936). That
Keynes' vision did not come true is due to many things, including
destruction of capital by wars, dilution of capital by population
growth, and an enormous increase in consumption in wealthy countries
such as the US, fed by novel products, advertising, and financed not
only by reduced savings and investment, but also by capital
decumulation. In the US this decumulation takes the form of enormous
consumer debt as well as huge continuing deficits in both the domestic
budget and the foreign balance of trade. In addition, regardless of
the marginal efficiency of capital, the interest rate has been kept up
by the Fed in order to attract foreign investment from our surplus
trading partners, and to avoid inflation -- as well as by the Fed's
feelings for the rentier class that are more tender than were Keynes'.
Nevertheless Keynes, like Mill, saw a real possibility that was simply
rejected by the growth mentality, to which of course conventional
"Keynesian economics" has itself contributed to substantially.

The classical view of the steady-state economy was replaced by the
neoclassical view for two historical reasons. First, the neoclassical
subjective utility theory of value replaced the classical real cost
theory of value that emphasized labor and land. There are no obvious
limits to growth in utility (a psychic magnitude), as there are to
growth in labor and in the physical product that labor extracts from
nature. Second, with the advent of the industrial revolution there
came the enormous subsidy of fossil fuels. The annual flow of solar
energy captured by land and harvested by labor was now supplemented by
the concentrated sunlight of millions of Paleolithic summers
accumulated underground. Growth now seemed limitless, and neoclassical
economists attributed this bonanza not to nature's nonrenewable
subsidy, first of coal then of petroleum, but to human technological
invention that was taken to be renewable and not limited to the
particular resources being exploited. Indeed, a general presupposition
of neoclassical economics is that nature does not create value. Peak
oil signals the end of the bonanza with no alternative subsidy in
sight, either from nature or human invention. And even before the
source limit of global peak oil hits, we have begun to experience the
sink limit of greenhouse-induced climate change. Not only are the
sources emptying, but the sinks are filling up as well. A modernized
classical view of the steady-state economy as a subsystem of a finite,
non growing, and entropic biosphere, as foreseen by Mill, must now
replace the misnamed, misconceived, oxymoronic, and temporary "steady-
state growth" still celebrated by the neoclassical economists, even as
the oil bonanza is burning out.

Many will say that I am selling technology short, and that it will
find a substitute for cheap oil. Even assuming this were true, should
we not limit our depletion of petroleum now to drive up prices and
provide an incentive for developing these new hoped for technologies
as soon as possible? Should not the technological optimists have the
courage of their convictions and provide the incentives to develop the
very technologies of which they are so confident? A policy of
frugality first will induce efficiency as a secondary response: our
currently favored policy of efficiency first does not induce frugality
second, and in fact makes it less necessary, as often documented in
the so-called "rebound " or "Jevons effect." The most obvious policy
response to peak oil, and to furthering the classical steady-state
economy is to shift the tax burden from "value added" (income produced
by labor and capital) and on to "that to which value is added", namely
the resource throughput, especially fossil fuels. We need to raise
public revenue somehow, so why not tax what is truly most scarce, and
is not the product of anyone's labor, rather than tax labor and
entrepreneurship? Why not tax resource rents, "unearned income" as the
tax accountants so honestly call it, instead of earned income or value
added in the form of wages and profits? This is not only fairer but
also more efficient because it raises the relative price of the truly
scarce and long run limiting factor, the throughput of low-entropy
matter-energy, natural resources. In addition to being the long run
limiting factor the resource throughput, principally fossil energy, is
also the factor most responsible for external environmental costs --
another reason to raise its price by taxation. The tax shift could be
revenue neutral, taking the same amount from the public but in a
different way. It would offer an opportunity to get rid of some of our
worst taxes (e.g. the payroll tax) at the same time we add taxes with
better incentives. To the extent that a throughput tax reduces its
base, that is all to the good since throughput is depletion and
pollution, both costs. However, such reduction is likely to be limited
because resources are absolutely necessary for production and both
demand and supply for them are inelastic. But taxing a factor with
inelastic demand and supply is minimally distortionary, whereas the
supply of labor and enterprise is more elastic, and taxing them is
likely to reduce the incentive to add value. It is true that a
resource tax, like any consumption tax, is regressive compared to an
income tax. However, even the Mafia, drug dealers, crooked
politicians, illegal aliens, and Enron executives would have to pay
taxes on their condos, Mercedes, and yachts, whereas they currently
manage to escape income taxes by off-shoring, trusts, special lobbied
tax exemptions, or submersion in the cash economy. In any case, as
even neoclassical economists have long correctly argued it is better
to help the poor by direct income supplements than by indirectly
lowering prices through tax subsidies. A subsidized price gives the
most money to the biggest consumer, who is usually not poor.

Why is such a simple and obvious policy not advocated by neoclassical
economists? Because for them natural resources are unimportant and
ultimately non scarce. If this sounds extreme remember that the usual
neoclassical production function in micro economics omits resources
altogether -- production is seen as a function of labor and capital
only. And if sometimes neoclassicals do include R into the equation it
makes little difference because the multiplicative form of the usual
production functions implies that manmade capital is a good substitute
for resources -- you can bake a ten-pound cake with only five pounds
of flour, eggs, and sugar, if only you use a big enough oven and stir
vigorously! And, with admirable consistency, macroeconomists calculate
our national income without attributing value to resources in situ.
Resources are valued according to their labor and capital costs of
extraction (value added), and any royalty paid for resources in situ
is simply a premium paid for access to a mine or well whose extraction
costs are lower than the margin that it is currently profitable to
exploit. All resources are free gifts of nature, but some gifts are
easier to unwrap than others and therefore trade at a premium.

Paralleling the shift from a real cost (labor and capital) to a
subjective (utility) theory of value was a shift from classical
commodity money (gold) to fiat money (paper). Just as value measured
by subjective utility loses its connection to the objective factors of
labor and land, so value symbolized by fiat money loses its connection
to the real costs of mining gold, especially when amplified by
fractional reserve banking. Both utility and fiat money are
unconstrained by the biophysical world of finitude and entropy that
characterize resources, land, labor, and physical wealth. The token or
counter of wealth, money, is now governed by laws different from those
that govern real wealth. Fiat money can be created and destroyed;
physical wealth cannot. Money does not spoil or entropically
disintegrate over time; real wealth does. Money does not take up space
when accumulated; real wealth does. Money spontaneously grows at
compound interest in a bank account; manmade capital does not -- its
spontaneous default tendency is to diminish. The world of money, debt,
and finance becomes increasingly disjoined from the world of real
wealth and physical resources. The financial world is built around
debt and expectations of future growth in wealth to redeem the debt
pyramid built by expansion of fiat money. Peak oil will disrupt those
growth expectations and lead to a financial crash resulting in levels
of real production that are even below physical possibility, as
happened in the Great Depression.

The steady-state economy needs a money more congruent with real
wealth. Hubbert in his early writings suggested an energy-based
currency. The history I have sketched may suggest a return to gold or
some other commodity money. I would favor a continuation of fiat
money, but subject to the discipline of one hundred percent reserve
requirements, as suggested by Frederick Soddy, Irving Fischer, and
Frank Knight -- but that is another story.

There is a bright side to peak oil if we can adapt to it. Obviously
lower inputs of petroleum will, other things equal, reduce outputs of
CO2 and greenhouse effects, albeit with a lag. Also, higher prices for
petroleum will act not only as an incentive to more efficient
technology, but also as a tariff on all international and long-
distance trade providing protection to national and local producers,
thereby increasing local self-sufficiency and slowing down the lemming
rush to globalization. Without the subsidy of cheap oil the rates of
exploitation and takeover of the natural world by mining, drilling,
cutting, draining, filling in, digging, blasting, paving, dredging,
leaching, overharvesting, monoculturing, etc., will all be slowed.

The big obstacle to the steady state economy is our religious
commitment to growth as the central organizing principle of society.
Even as growth becomes uneconomic we think we must continue with it
because it is the central myth, the social glue that holds our society
together. Consider the Washington Post's recent editorial, "The Case
for Economic Growth" (4/2/06). They admit that the case for growth has
been greatly weakened in the US by the fact that most of the growth
for over a decade has gone to the rich and little if any to the poor.
Also, even that growth to the rich has produced little welfare in view
of studies by psychologists and economists showing that beyond a
$10,000 per capita GNP threshold self-evaluated happiness ceases to
rise with rising income. Despite these two blows, however, the
Washington Post believes the case for growth remains strong, for two
additional reasons. First, as Americans become richer they become more
optimistic and tolerant, and therefore act more generously toward
racial minorities, immigrants, and the poor. Second, only a richer
America can continue making the world safe for free trade and
democracy. If the mouthpiece of official Washington can't make a
stronger case than that, then I think the growth ideology may finally
be in trouble. But notice that even to make that weak case they had to
assume that growth in GNP is in fact making us richer, when that is
the very point most at issue in the growth debate! The evidence is
that at the current margin growth increases environmental and social
costs faster than it increases production benefits, making us poorer,
not richer. Furthermore, by their own admission nearly all GNP growth
has all gone to the rich. It has not, therefore, led us to act more
generously to the poor. Is that because GNP growth has in fact not
made us richer, or perhaps because generosity has little to do with
wealth in the first place? Nevertheless, this is the level of
reasoning that passes for serious economic discourse in Washington DC.
Does it reflect honest confusion, or cynical pandering to the ruling
class ideology? In either case it falls far short of John Stuart
Mill's 150 year-old analysis.

In the absence of a good substitute for petroleum, something currently
not identifiable on the required scale, peak oil will signal an era of
rising prices and dwindling supplies of the major energy source of the
industrial economy, requiring a thorough adaptation of the economy to
more severe geological and biological constraints. The classical
steady-state economy is a way of thinking accustomed to adapting the
economy to reality. The idea of a steady-state economy predates and is
independent of peak oil -- this is true even for M. King Hubbert who
wrote about the steady state long before his famous prediction of US
peak oil. But the growing evidence that we are close to peak oil for
the world should dramatically increase interest in the classical
steady-state economy as a better fit for the real world than the
current neoclassical perpetual growth machine. Does someone have a
better idea?