Energy in Economics

Modern lifestyles are reliant on an abundant supply of energy. We use electricity to charge our phones (and so access the DSEP Facebook group, or anything else online), boil the kettle, light our houses, etc. To travel further than lectures, we almost always use some form of oil for transport, as does your Amazon delivery, or the food driven to Tesco so that we can buy it. Yet energy plays no role in the capital/labour obsessed models of neoclassical economics. Pluralism is crucial to understanding the role and issues of this too-often overlooked factor of society.

Another way to understand the importance of energy in the world is to picture the work it does. The energy contained in one single gallon of oil is roughly equivalent to 47 days of human labour; our daily use of it is equivalent to the work of billions of unpaid, invisible workers. Market forces are what enabled the development of cheap fossil fuels which facilitate modern lifestyles. Work by a physicist and an ecological economist in 2009 proposed a new model of economic growth, including energy as a third factor of production. Using this model, they found a Solow residual which attributed only a tiny amount of growth in 20th century US, UK, Japan and Australia to technological shocks. A far larger fraction of the growth was instead the result of increasingly efficient use of energy in production.

Yet, despite its paramount importance to production and the modern economy, energy doesn’t get much attention in neoclassical economics. When it is considered, it is treated more or less as any regular commodity, like pizza or lattes. However, the use of fossil fuel resources, which account for the vast majority of our energy, has considerable externalities- a concept which is in itself flawed. Externalities suggest emissions and the resulting global warming, which is already causing climate disasters, should be treated as a sort of afterthought to the main act of fossil fuel energy consumption. There are many other issues too, such as energy poverty and the role of fossil fuels in global geopolitics, to name just as few.

Orthodox economics has some major blind spots when it comes to energy and so, to acknowledge this, should only be used in conjunction with alternative schools. Ecological Economics incorporates the dependence of economic activity on biophysical systems at its heart, attempting to capture the full picture when analysing the relationships between them. It also begins from the perspective that in economics, as a social science, “facts” are inseparable from the values under which the economy works; choosing to use finite gas resources now means we are valuing our consumption of it over leaving it for future generations. That isn’t a criticism, but it should be acknowledged as a common understanding.  Bringing some of Ecological Economics’ insight to the mainstream would be a very good start to properly understanding energy in society and shaping policy appropriately.

Behavioural and Experimental Economics can also play an important role in analysing and developing the existing economic institutions for energy. In the UK, a particular type of auction is run for developers of renewable electricity: each firm bids a level of government-backed “strike price” for their generation- effectively they bid for lower and lower subsidies. Once a given amount of electricity generation has been allocated from the lowest bid upwards, each bidder receives the highest strike price that was accepted. Behavioural Economics has contributed extensive work on auctions and helped explain versions of strategic bidding which can be applied in this situation. This is a pluralist success story; these behavioural theories have been used for tweaking electricity markets across Europe.

Nobody wants to surrender convenient transport, the internet, cups of tea or mass manufactured goods. Growing populations mean our energy demands are likely to continue to grow this century. In the face of climate change, a rapid transformation of our energy inputs, from fossil fuels to renewables, is desperately needed. It is already gathering considerable steam. Add to this electric vehicles, battery storage and a whole host of other changes, and it appears it has never been more necessary to understand the incentives at play in Energy Economics. It’s time to use all the tools we’ve got.

Want to know more? Doughnut Economics by Kate Raworth and Student Energy Durham are good starting points.


Tom Hinson


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