Tuesday, August 16, 2011

world economic crisis and energy economics

Important as it is, energy is probably less than half of what we would need to get right
for an optimal recovery from the world economic crisis. But energy economics has some important
things to tell us about the other half, too.

There has been a kind of interesting debate about world economic recovery in the Financial Times (FT) today and yesterday.
Yesterday, Clive Crooke, their most visible regular op-ed writer, bemoaned the lack of real economic leadership in the world,
which keeps us from doing more than just muddle through. (I wonder whether the President's new jobs proposal is motivated in part by such feelings?)
Today, there was a kind of dual response. Lagarde, the new head of the IMF, agreed that we really can do better if we do not give in to despair
and false beliefs that we cannot do a whole lot better. Someone else basically disagreed, and said we do not need strong military type leaders like
Churchill (or Napoleon or HItler?) in the face of big economic challenges.

Comparing where we are with where we could be... (much worse or much better)...

where we are basically feels like a kind of stable balance of forces. It feels a bit like those general equilibrium models in economics
where, for all the fluctuations, things basically settle down to a certain kind of state. That kind of feeling may be limiting people's
energy in trying to find another way.

But general equilibrium models can be misleading at times. There is a kind of shocking reality that
the economics textbooks don't talk about much. (At least, I never saw mention of it across many courses in economics at Harvard.)
There are wonderful theorems about unique general equilibrium across space and time, finding an optimal trajectory
from the present to the future, when economic actors all see that path. But all those wonderful theorems depend
on certain assumptions about the parameters in the models. The real world simply does not scrupulously make
those parameters live within the assumed ranges. And our theoretical training does not always prepare people for
how to live in a world where some of the parameters are 'way out of bounds.

It may well be that we are in a global situation right now where there are three relatively stable
locally inescapable solutions to the future path, the general equilibrium across space and time
for actors who have reasonable foresight -- today's muddling through, Great Depression II,
and "return to normalcy." (As in the Clinton Camelot era?).

Two experiences in energy economics may give a few clues about how this works.

First, in my first tenured job long ago, at DOE, I led a couple of efforts to evaluate the issues of existence and uniqueness of solutions to the
Long-Term Energy Analysis Program (LEAP), a true General Equilibrium Model which was used to generate the long-term forecasts included
in the Annual Energy Outlook. (It was actually a lot more advanced in many ways than the "new" NEMS model,
which is basically just a rerun of the old MEMS model, which tried to use linear representations of the economy.)
I was able to prove existence and uniqueness UNDER CERTAIN ASSUMPTIONS (as in an ancient EIA publication still somewhere
in the DOE documents database), but for the general case, a team at Oak Ridge working under me did find realistic counterexamples.
I was reminded of this yesterday, when I needed to find a citation; I hope their later journal paper does justice to this:

C. R. Weisbin, R. W. Peelle and R. G. Alsmiller, Jr., An assessment of The Long-Term Energy Analysis Program used for the EIA 1978 report to Congress,Energy Volume 7, Issue 2, February 1982, Pages 155-170

Second, and stronger, I later had occasion to work with Dale Jorgensen's famous macroeconomic model of the US economy,
which brought in more microeconomic concepts of general equilibrium that you can find in most of the more ad hoc, heuristic (and politically tuned)
macroeconomic models from the most profitable vendors of models. The model was famous for "KLEM" -- for paying real attention to the role of energy inputs (E)
in affecting the economy. We initially hoped that his rigorous approach to predicting industrial energy demand, as a demand derived from
production and profit maximization in industry, would do better than some of the ad hoc heuristic approaches used before then.
But my experience with that model was painful and shocking, not only for me but for Jorgenson. In reasonable backcasts,
it had something like 50% error in predicting variations in industrial energy demand. There was no reasonable way out.
The model had REQUIRED elasticities of demand of -1 or more -- HIGHLY ELASTIC demand -- as required by the general equilibrium
assumptions. Those assumptions were grossly violated. There was an "adjusted R-square " of about 99%, which was basically saying that he did the best he could WITHIN THE LIMITS of this assumption.

These are hints, not a new paradigm or model. They hint that inelasticity of demand has a lot to do with the multiple solution situation we are in.
In fact, inelasticity of supply AND demand in the oil market has a lot to do with the volatile and dangerous state of the world economy
for the coming decades. A key benefit of global sustainable energy systems would be more elasticity on the supply side.


This also reminds me a bit of the story of Joan Robinson, an economist who was mentioned in passing at Harvard, whose
heroic story may deserve more attention. (Not that I know it as well as I should.) For many years, the ASSUMPTION
of perfect competition was very entrenched in market economics, all over the world. She was (so far as I know) the leader in extending
ordinary market economics and price theory to the case of IMPERFECT competition, where companies really account for
their market power in being able to make customers pay more. When I went to Harvard, this was taken for granted. Yet there
had been a lot of ideological pressures form people who wanted to assume and declare that ALL markets are perfect,
and that we shouldn't look with suspicious eyes at monopolies or near-monopolies. Simple common-sense reality does not
always get full play in the face of such pressures. And with the way that things are going these days in the US, I worry whether we will
revert back to the days when questioning monopoly is no longer tolerated so much. It reminds me of Teddy Roosevelt -- a strong leader that
the guy at FT didn't mention this morning, who played a crucial role in moving the US to a better, stable trajectory at a time
when things were looking very bad indeed for the US and for American ideals.

Of course, political pressures are not the only thing which tends to impoverish our theoretical analyses.
I often remember the old saying "a theorem a day keeps the chairman away" -- whose full import I did not appreciate until years later.
There was a joke in engineering a few years ago about what happened when people started applying modern adaptive control to large plants -- and a large chemical plant simply blew up due to its instability. The joke is that the industry people said they would never use adaptive control again, while the
academic people worked very hard cranking out tons of theorems proving it is absolutely stable (under certain
mild assumptions...). Only recently have people really seriously started developing massive changes in adaptive control, which
make the required assumptions a whole lot weaker... which avoid instability under a wider range of more normal conditions.
And in fact, what reminded me of all this yesterday was an overdue chapter for the latest book on those new directions...
edited by Frank Lewis of the University of Texas...

But stability with sustainability and growth in the world economy is not the simplest of challenges...


On the Lifeboat Foundation list, I went further:

The discussion of genes, antisocial behavior and the threats it is leading to
are very interesting... but I wonder whether a little more context
might enrich the analysis.

On a more international discussion list, people have questioned
whether traditional Western style
economic growth is really possible any more. Have we reached the
limits of an inevitably finite phenomenon... like
the top of a curve as a baseball flies into the air, only to come
crashing down into the ground?

I replied (quickly and roughly) that it really should be possible, in
principle, for the entire world to experience continued economic
for a long time, enough for the whole world to enjoy a standard of
living at least as good as what a lot of Americans have become used

1. Continued population growth. Even at 1% per year, we will
impoverish and perhaps kill ourselves off if it is not stopped sooner
or later.
That's not the main thing I want to address in this email... but the
issue will come back, since it certainly links to those natural
selection issues.
Many narcissistic pseudo experts proclaim that the problem is solved
because of certain UN projections... but those particular UN
are goals, not projections. It's a long story, but the bottom line is
that we are not out of the woods, no matter how entrenched the vested
who want this to be a taboo topic.

2. Barriers to new technology. The technological options do exist to
allow US-level standard of living for all the world, for
millions of years, for the present world population, sustainably... if
we develop and deploy them effectively. Much of my own life has been a
struggle against the
barriers to that kind of progress, and of course it requires a lot
more than one person.

3. Will we kill ourselves anyway, out of sheer cussedness, craziness,
and psychological entropy? Will the human race be like
one of those rich heirs, who have all they need, but simply go nuts
and shoot themselves?

The discussion of natural selection here in the last few postings has
mainly focused on the third question, which
is really quite worrisome. Could it be that our genes dispose us to a
kind of conflict which will inevitably cause humans
to just bring down the house? (Of course, we don't have to worry about
chimpanzees bringing down the house, even with the same
kind of genes, because they don't have nuclear weapons. At least not yet.)

This ties into some questions about the world economic crisis, which I
have tried to think about from time to time lately.
(For example, see
http://drpauljohn.blogspot.com/2011/08/world-economic-crisis-and-energy.html .)

A lot of the models of natural selection remind me a lot of Nash
equilibria in game theory, which have become important
in modern engineering. For example, many people want to use a kind of
natural selection and competition
between multiple agents -- multiagent systems (MAS) -- to manage
complex systems like electric power grids.
(See the August issue of IEEE Computational Intelligence magazine.)
But the outcome of natural selection is not always benign,
as some have noted on this list. In the general case, Nash equilibria
are NOT Pareto optimal, not a win-win solution, not the kind
of outcome which is the best for ANY of the players of the game.

SOMETIMES Nash equilibria are decent and sustainable; sometimes they
are not even sustainable; sometimes
they are even close enough to Pareto optimality. It all depends on the
rules of the game. In electric power, there has been more
and more interest in MARKET DESIGN -- DESIGN of the rules of the game
such that the market equilibrium really is Pareto optimal, or close
enough to it.

But what about this world economy, which seems to be going to hell on
many levels, and certainly does pose risks
of extinction in the end to the whole species? Is there a way that we
could structure things (the "game" or the "niches") such that they do
NOT go to tell,
either with Nash equilibrium or natural selection or whatever?

(This is not just loose talk. Great Depression II is quite possible. I
am reminded of how I just couldn't control my stomach the other day
after drinking
too much iced tea and shopper's fried chicken on a green yacht in the
Chesapeake.... And then, if we have Great Depression II, consider
what the
political and military implications were of Great Depression I, back
before nuclear weapons and such a multipolar world as we now live in.

I don't see a clear path here, but I wonder...

In electric power, new computers and algorithms have been absolutely
crucial to new market designs which overcome
many of the problems of the past. (Yesterday I finished a book chapter
on some new relevant algorithms which are relevant here.)
But is there any way they could help do the same for the stickier sort
of game we see playing out in the world
economy as a whole?

Last week Juergen Schmudhuber suggested to me that we could at least
use intelligent systems for financial clearing systems,
to get rid of the irrational arbitrage possibilities which lead to an
excess drain of money funding microsecond-level traders.
(That reminds me of how getting rid of irrationalities which lead to
arbitrage possibilities have been important in electric power.
Outside traders can help the system, but only if it is well designed
enough.) That would be a step forwards. It might not even be a tiny
step forwards,
because the big conflicts in Washington clearly show a schism between
fundamental investors who care about lasting long-term value (like
versus glassy eyed manic types who make money on Wall Street through
fast myopic games and donate lots of money to the misnamed
"Club for Growth" (a club to extract as much tax breaks from the US as
possible, without asking a lot of questions about how long the US can

But what about the larger system?

So far as I can tell, the nations of the world are stuck in an
inferior Nash equilibrium, which prevents any of them from really
moving to full
economic recovery in the one or two years we became used to in the US
after World War II. (Many other nations have experienced
"lost decades" in this period.) In theory, they could get out of this
, and acquire at least an option for rapid economic recovery,
if they somehow could achieve some kind of arrangement for one to four
crucial variables... the most important being real interest rates.
For example, for the United States, Greece and France, the issue of
interest rates (and oil prices) is entangled
with any hope of rapid recovery, in several ways.

A major difficulty in finding a way to use new algorithms is the
inevitable role of human judgment in these systems.
George Soros (an op-ed in Financial Times today?) has a suggestion for
solving the eurozone crisis by a new mechanism
for a new kind of eurobond, which inevitable relies on bankers glaring
across the table at national governments,
just as bankers issuing mortgages have to judge credit risks, and NSF
program directors and reviewers
have to make difficult decisions about research proposals.

What can be done about the rules of THESE kinds of games?

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