and physical reality
Energy Economics, University of Cologne, Germany)
Reiner Kümmel (Institute of
Theoretical Physics, University of Würrzburg, Germany)
Since Georgescu-Roegen´s statement on entropy, there
has grown a vast literature on the implications of the laws of thermodynamics for
economics. Most of this literature is related to the environmental consequences of the 2nd
law, i.e. that any economic activity unavoidably causes pollution1.
This important insight could, at least to some extent, be integrated into (environmental)
economic theory. Other implications of thermodynamics will probably be more difficult to
be incorporated into the prevailing neoclassical framework, if this is possible at all. An
example is the notion of irreversibility, which implies at least some sort of
non-equilibrium. A corresponding micro-economic modelling approach was proposed recently
in this journal . Another example is discussed in the following. We address the issue
of appropriately including the indispensable production factor energy into
macro-economic theories of production and growth, and try to draw some conclusions.
In conventional neoclassical theory the production factor energy is either neglected
altogether, which is inconsistent with thermodynamics, or attributed only marginal
importance. The argument is that energy's share in total factor cost is small compared to
the cost shares of labor and capital. However, the recessions after the oil price crises
in 1973/74 and 1979/81 have posed the question how a production factor of monetarily minor
importance can have such grave economic consequences.
The conventional view of the low economic importance of energy dates back to the first
stages in the development of neoclassical economic theory. Initially, the focus was not so
much on the generation of wealth, but on its distribution and the efficiency of markets.
Consequently, the early thinkers in economics started with a model of pure exchange of
goods, without considering their production. With a set of assumptions on rational
consumer behavior it was shown that through the exchange of goods in markets an
equilibrium results in which all consumers maximize their utility in the sense that it is
not possible to improve the situation of a single consumer without worsening the situation
of at least one other consumer (Pareto optimum). This benefit of (perfect) markets is
generally considered as the foundation of free-market economics. It shows why markets,
where "greedy" individuals meet, work at all. But later, when the model was
extended to include production, the problem of the physical generation of wealth was
coupled inseparably to the problem of the distribution of wealth, as a consequence of the
model structure: Since the neoclassical equilibrium is characterized by a
(profit-maximizing) optimum in the interior -and not on the boundary- of the region in
factor space accessible to the production system according to its state of technology,
factor productivities had to equal factor prices. In the resulting production model the
weights with which the production factors contribute to the physical generation of wealth,
i.e. the elasticities of production, have to equal the factor cost shares. These cost
shares, in the industrialized countries, are typically 0.7 (labor), 0.25 (capital) and
Consequently, according to the neoclassical model, the elasticities of production of
the factors, which -roughly speaking- measure the percentage of output growth if a factor
input increases by one percent, would have to have these values: labor 0.7, capital 0.25,
and energy 0.05. With these input weights a decrease of energy utilisation of up to 7%, as
observed during the first oil crisis between 1973 and 1975, could explain a decrease of
value added of only 0.05(7% = 0.35%. The actually observed decreases of economic output,
however, were roughly ten times larger.
Furthermore, a substantial part of observed long-term economic growth cannot be explained
by the growth of the factor inputs, if these are weighted by their cost shares. Large
residuals remain. In most cases the residuals play a more important role than the
explanatory factors, which, according to Gahlen, makes the neoclassical theory of
production tautological . Solow, after noting "...it is true that the notion of
time-shifts in the [production] function is a confession of ignorance rather than a claim
of knowledge'' , comments: "This ... has led to a criticism of the neoclassical
model: it is a theory of growth that leaves the main factor in economic growth
As it has been shown recently, the residuals of neoclassical growth theory can mostly be
removed by taking into account the production factor energy appropriately [5-11]. It turns
out that the crucial point is to drop the neoclassical equilibrium assumption, and to
determine the elasticities of production of the factors by purely technological and
empirical considerations instead. Thereby, the previously unexplained technological
progress reveals its two principal elements: The first one is the activation of the
increasingly automated capital stock by energy; and, of course, the people who handle
capital have to be qualified appropriately. The second one consists of improvements of
organizational and energetic efficiencies of the capital stock. The short-term impact of
the first element is much bigger than that of the second element, but the reverse may be
true for the long-term impact, if efficiency improvements fundamentally change the course
of economic evolution . The efficiency improvements are identified by shifts of the
corresponding technology parameters in the production functions, whereas energy's high
productive power in increasingly automated production processes is revealed by its high
elasticity of production: Energy's elasticity, in industrial sectors of the economy, is
typically of the order 0.5, i.e. as large as those of capital and labor together. In
service sectors it still exceeds energy's low cost share significantly . Both in
industrial and service sectors, labor's elasticity is far below its cost share. Only in
the case of capital, do elasticities of production and cost shares turn out to be roughly
in equilibrium, as neoclassical theory presupposes.2
What are the consequences of these findings? Let us frame one selected point as
follows. If wealth had been distributed according to the "marginal productivity
theory", labor would have received only a share of national income much smaller than
the observed 70%. But apparently, in the past most of the value added by energy was
attributed to labor. The underlying mechanism of distribution was that of
wage-negotiations in which free labor unions, powerful during times of high employment,
regularly succeeded in winning wage increases according to the growth of productivity,
i.e. increased production due to increased and more efficient energy utilization. This way
most of the population in the industrialized countries benefited from the wealth generated
by the production factors capital, labor, and energy.
With increasing automation in production, however, human routine labor becomes more and
more dispensable. A possible consequence is the increasing inequality in the distribution
of income, as can be observed in the US, where, due to flexible labor markets, the hours
worked per year have increased, but the problem of the "working poor" remains
unsolved. Consequently, if society wishes to organize labor markets more competitively,
while socially unacceptable distributional effects are to be avoided, the question arises
how the institutional settings within market-economies have to be adapted to the changing
Certainly, increased investments in education and the design of appropriate labor
market and social policies are crucial issues. Here, let us address the issue of how such
policies may be financed in a sustainable way. In the past the financial burden resulting
from social policies was mainly put on the production factor labor. This is one of the
causes of the identified disequilibrium between the cost shares and productive powers of
labor and energy, which, in turn, accelerates technical progress towards increasing
automation. If this disequilibrium is sufficiently steep, the newly emerging and expanding
sectors of the economy will no longer be able to compensate for the losses of jobs due to
increased automation in the existing industries, thus destabilizing the system as a whole.
Therefore, in view of social and fiscal stability, it might be worthwhile to consider a
shift of taxes and levies in the industrial countries in such a way that the production
factors labor and energy are burdened more according to their productive contributions to
1. I.e., the emission of heat and substances into the
environment due to entropy production.
2. The production systems are operating in
boundary cost minima in factor space, where the boundaries, at a
given point in time, are established by the state of technology in information processing
and automation and
prevent the system from sliding at once into the absolute
cost minimum of nearly vanishing labor input.
Martinás, K., "Is the Utility Maximization Principle Necessary?", post-autistic
economics review, issue no. 12,
March 15, 2002, article 4 and references therein, http://www.btinternet.com/~pae_news/review/issue12.htm.
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Mohr, Tübingen, 1972.
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K.J. Arrow, S. Karlin, and P. Suppes (Eds.). Stanford, 1960, p. 89-104.
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Workshop of the Max Planck Institute for Research into Economic Systems, Jena, 2001.
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Natural Sciences with Economics, BioScience 51 (8), 2001, 663-673.
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Diffusion, Structural Change and Economic Dynamics, 2002 (in press),
(fields of research, Ref. 14).
Lindenberger and Reiner Kümmel, "Thermodynamics and Economics", post-autistic
issue no. 14, June 21, 2002, article 1. http://www.btinternet.com/~pae_news/review/issue14.htm