Accounting for Energy in Economics

Economist Steve Keen previews his upcoming book with a discussion of accounting for the role of energy in models of production (or GDP).

Keen notes that the standard model treats energy as a “factor of production,” meaning that energy consumption levels of a process have a direct effect on output levels. This makes intuitive sense, but Keen argues that the intuition is flawed. Instead of a simple factor of production, energy must be viewed as a discrete input.

(You can see the math in the video here, at 18:20-24:00 minutes.)

As a result of this intuitive shift, the effect of energy on production is 10 times greater than economists have assumed it to be. This makes better intuitive sense in that it forces a baseline of zero production based on zero energy for labor or technology, but it has other implications that worry Keen greatly.

One is that assuming an unrealistically low energy effect on production has enabled unrealistic climate-change assessments. If you assume, for example, that labor and capital can easily make up for energy losses in the production equation, you might be tempted to imagine that renewable forms of energy are a valid replacement for non-renewable forms despite being less reliable. Or, you might imagine that real climate change will have little impact on production.

I find Keen’s reassessment of energy as an input to production compelling. In a way, it is like finding the Holy Grail of economic value, a way of translating dollars into BTUs.

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