Principles of Ecology: Business cycles and money

1. Principles of Ecology:Business cycles and money Lecture III November 18, 2010 Karl Seeley, PhD Hartwick College, Oneonta NY

2. Data from Penn World Tables, 2007

3. Data from Penn World Tables, 2007 Czech Republic

4. Data from Penn World Tables, 2007

5. Data from Penn World Tables, 2007 Czech Republic

6. Outline, November 18 • Resource supply curves • Circular flow • Sustainable growth • Money • Unsustainable growth • Investment (physical process, financial process)

7. Exhaustibles over time PE New discoveries Construction of capacity for extraction New extraction technologies New technology and discovery not keeping up with depletion of the stock (There’s still some cheap oil) E Emax Emax Emax Emax

8. Fossil fuel supply curves • Easy to move rightward • Concentration and density • Can keep moving rightward as you: • Find new reserves • Invest in extraction capacity • Develop new fields • Move leftward as you extract fuel

9. Renewables over time Discovery/conquest of new land Clearing of forest for agriculture Fishing boats that go further from shore Soil exhaustion Depletion of fish stocks Cutting of most/all available trees PB More powerful timber harvesting equipment Bmax Bmax Bmax B

10. Renewables supply curves • Move rightward with: • Better harvest techniques • Conquest of new land • Investment in harvest tools • If harvest is only natural growth, then nothing pushes curve leftward • If harvest is high, or other activity damages, then curve moves leftward

11. Solar constraint • Renewable curves are subject to the “solar constraint” • Ultimately limited by the flow of current sunlight, and the ability to capture, convert, and concentrate it • In one place, you can’t expand very far before overharvest • Because it’s diffuse, it tends to be more expensive than fossil fuel

12. Fossil-renewable interaction • Fossil fuel frees up renewables • By replacing biomass as an energy source • Brings within reach formerly inaccessible stocks of renewables • For a while, can compensate for declining health of renewables • Increased chance of overharvest • Fossil fuel: Both a new resource, and a means of increasing supply of old resources

13. 2-field agriculture Field operations 22 20 5 11 Soil improvement 15 25,000 200 Fallow 5 7 11 24,805 Animals 180 17 2 23 Sun 30 11 3 45 25,000 400 People Crop 24,628 325 28 Some energy is growing the crops Some energy is driving ecosystem services (e.g., restoring fertility)

14. Generalized pre-industrial human ecology Humans Food Ag Industry Ecosystem services Sun Eco-systems Raw materials, motive power Agriculture is solar-based, also relies on ecosystem services Industry uses energy from animals, wind, water, animals, and humans Materials are derived from plants and animals (and minerals)

15. Early-industrial human ecology Humans Food Ag Industry Ecosystem services Sun Eco-systems Coal Population, agriculture, and industry all expand Increased competitive exclusion of other ecosystems Coal introduced as additional source of industrial energy (and raw materials)

16. Advanced industrial human ecology Oil, etc. Food Ag Humans Sun Industry Ecosystem services Eco-systems Coal, oil, nuke, etc. Further expansion of population, industry, agriculture Increased use of fossil fuel in industry (Near) elimination of human motive power Introduction of fossil fuel to agriculture Further shrinking of ecosystems

17. Production (output) • Y = F(K, N, A, R) Production (output) is a function of • Capital (K) • Labor (N) • Technology (A) • Resources (R) • Standard approach omits resources Y = F(K,N,A)

18. Long run vs. short run • The long-run trend since the Industrial Revolution has been growth • Sometimes faster, sometimes slower around that trend

19. GDP Trend Actual Time

20. Long run vs. short run • The long-run trend since the Industrial Revolution has been growth • Sometimes faster, sometimes slower around that trend • Increasing capital, improved technology, increased resource use • Increasing output per worker • No growth means falling employment

21. Recession • Falling GDP • Or growth too much slower than trend • Higher unemployment • Capital idle • Resource use declines

22. Uses of output • Y = C + I + G + EX – IM • Consumption • Investment • Government expenditure • Exports • Imports • National Income Accounting Identity • This is about technical possibility • How much can you produce and how will it be used? • But why produce?

23. Circular flow diagram Wages, capital rent ($) II. Including investment Labor, capital Export expenditure (Ex) Firms Households (HH) Goods, services ($) Import expenditure (Im) Consumption expenditure Financial markets I S T G Government

24. Aggregate demand • The sum of all final expenditure in the economy Consumption Investment Government expenditure Imports minus exports AD = C + I + G + Ex – Im • The same stuff as GDP • The motivation for production

25. Supply vs. demand • Supply-driven model • The economy is going to produce what it’s going to produce (Y) • Divided in different ways (among C, I, G, Ex, Im) • More for one of those means less of the others • Demand-driven model • Economy responds to more demand by producing more • More of one (C, I, G, Ex) results in more of others

26. Circular flow diagram W II. Including investment Firms Households (HH) Export expenditure Import expenditure C Financial markets I S T G Government

27. Circular flow diagram W II. Including investment Firms Households (HH) Ex Im C Financial markets I S T G Government

28. Composition of GDP • Consumption is usually about 60% - 70% of the total • Government ~20% • Investment fluctuates a lot, 10% - 20%

29. Standard B-cycle explanation • “Exogenous” drop in demand • Exports, or weakened consumer confidence • Or reduced investment expenditure • Circular flow amplifies this “shock” • Output goes down, and employment • Renewed demand puts unused resources to work … eventually • Government policy can create demand, shorten the process

30. Reconciliation • Ecological model accounts for long-run growth • Ecosystems have fluctuations in “output” • Volcanic eruptions, droughts, sun-spot cycles … • In agricultural economy, similar drivers for “business cycle” • In industrial economy, only contributory • In recessions, we “underutilize” everything, including ecosystems • The driver is finance • Controls rate of economic activity  Controls rate of use of ecosystems and resources

31. “Sustainable” growth • In economics, nothing to do with whether resources are being used “sustainably” • That’s very hard to define, anyway • Growth in purchasing power matches growth in productive potential • As workers get better at doing stuff, demand for what they make rises in sync, so that they keep being employed

32. Creating purchasing power • By making stuff • Out of thin air

33. Production-based buying power • Purchasing power can be created through production of things other people want • I make something, you buy it from me, I can buy something else • But this process generally supports current level of output • If demand is based on what’s currently being made, there can’t be demand for more than what’s currently being made

34. Money for growth • To cause firms to provide ever more output, there must be ever more demand • Easy way to do this is to create money out of thin air ?????

35. Essence of money? • Anything generally accepted directly as claims on current stuff • Cash • Checking account balances • Savings account balances (if there’s ATM access) • Instantly and at fixed rate converted to cash • Credit-card line

36. Money and time • You can exercise your claims on stuff immediately • You can wait till next week, next year, next decade • Though a credit-card company could revoke your credit line

37. Assets • Anything of value • House, cash, bank accounts, stocks, bonds, a factory, jewels, artwork • They are indirectly claims on current stuff • Though cash and bank balances are directly claims on current stuff • Other assets have to be turned into money before they’re effective as claims on stuff • Money values of assets can fluctuate wildly

38. What is credit? • Giving someone money now, in exchange for money later • Giving someone claims on current stuff in exchange for claims on stuff in the future • Credit card • Business loan • Mortgage

39. Earning future claims • In the future, how will you get claims on stuff, to pay off credit? • Get a job • Produce a good that you can swap for other people’s claims • Provide a service that you can swap for other people’s claims • Which is what getting a job amounts to

40. Assets and time • I hand Chris claims on stuff now, to buy a house • I balance that act with the right to a stream of claims on future stuff • The right to that stream of claims on future stuff (i.e., the mortgage) has value • I can sell the mortgage (e.g., to Alex) • Alex hands me claims on stuff now • He receives the right to a stream of claims on future stuff • By creating the mortgage, I’ve created an asset

41. Money for start-up • I need claims on stuff for my new company • Sell shares in the new company • e.g., 1,000 shares, each one owns 0.1% of company • Shares are rights to future claims on stuff • Future profits (resulting from production in the future) belong to share-holders • The right to future profits is worth something now • Though value depends on guesses about size and timing of future profit • Shares are an asset

42. Changes in asset values • My company could invent something BIG • Guesses about future profits jump • Value of right to those profits (stock shares) will jump • Chris could lose his job, stop making mortgage payments • The right to those payments loses value • Likewise, my company could go bankrupt rather than prosper … • … destroying the value of the right to future profits

43. Bank-made money • A loan: the creation of claims on current stuff in an account for you • Your suppliers will accept your checks • Claims on stuff are backed by your bank • Maybe pay off their own loan • Or put them in checking, buy something else in turn • Eventually, claims return to your bank for settlement • In the meantime, they’ve been acting as money • Meanwhile, other banks also creating loans • And some of those claims are making their way to your bank

44. The dirty little secret • In a legitimate loan or mortgage, the creation of claims on current stuff is balanced by rights to claims on future stuff BUT… • You can create a loan, even when the stream of claims on future stuff is implausible • The claims on current stuff are just as real, but no claims on future stuff will ever flow back

45. Money review • Money: • Any convenient thing generally accepted as claims on stuff • Assets: • Things of value • Indirectly claims on stuff • Financial assets • Physical assets • Productive: means of future production • Consumptive: means of future consumption

46. Money review, cont. • Credit: • Provision of claims on stuff now • Or claims on value in the present • Balanced by claims on stuff in the future • Or claims on value in the future • Always results in creation of a financial asset • May result in creation of a physical asset • If it’s not just used up in current consumption

47. “Unsustainable” growth • Government can spend too much through borrowing • Trigger excessive creation of purchasing power • 1960s, Vietnam War + Great Society • Govt. can encourage too much lending • Creation of purchasing power • Late 1990’s, this decade • Private sector can go crazy • This decade, housing bubble

48. Physical investment • Allocation of available inputs to creation of capital • Physical usefulness is given by capital’s ability to actually do something • Value depends on the value we put on that physical result • Investment can fail due to • Technical or resource problems • Output becomes obsolete or out of fashion

49. Investment as a financial process • Establishing claims on value to be produced in the future by relinquishing claims on valued stuff available now • You can buy or pay for the creation of a piece of physical capital • You will own the value created by that factory or warehouse or … in the future • A physical asset that is part of how the economy produces goods and services in the future

50. Pure financial investment • You can also create a financial asset • Instead of a physical one • Lend out money • Create purchasing power • Create an asset • Sell the asset for claims on stuff available now • Use those claims for stuff, or acquire a different asset • Maybe even a physical one, like a factory or warehouse