Navigating on the Titanic: Economic Growth, Energy, and the Failure of Governance 9781553395072

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NAVIGATING TITANIC ON THE

Economic Growth, Energy, and the Failure of Governance

Bryne Purchase

Copyright © 2013 School of Policy Studies, Queen’s University at Kingston, Canada

Publications Unit Robert Sutherland Hall 138 Union Street Kingston, ON, Canada K7L 3N6 www.queensu.ca/sps/

All rights reserved. The use of any part of this publication for reproduction, transmission in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), or storage in a retrieval system without the prior written consent of the publisher— or, in case of photocopying or other reprographic copying, a licence from the Canadian Copyright Licensing Agency—is an infringement of the copyright law. Enquiries concerning reproduction should be sent to the School of Policy Studies at the address above.

Library and Archives Canada Cataloguing in Publication Purchase, Bryne Brock, 1944 Navigating on the Titanic : economic growth, energy, and the failure of ­governance / Bryne Purchase. (Queen’s policy studies series) Includes bibliographical references. ISBN 978-1-55339-330-6 1. Economic development—United States. 2. Economic development—Canada. 3. Power resources—Environmental aspects—United States. 4. Power resources— Environmental aspects—Canada. 5. Climatic changes—Risk management—United States. 6. Climatic changes—Risk management—Canada. 7. Industrial policy—United States. 8. Industrial policy—Canada. I. Queen’s University (Kingston, Ont.). School of Policy Studies II. Title. III. Series: Queen’s policy studies series HD3616.U46P87 2013

338.973

C2012-908044-6

Dedication: Sandra Purchase 1946–2011 Thanks for everything. Love always. Bryne Brock

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Contents Preface.................................................................................................. vii Chapter 1: The Brief History of Economic Growth....................................1 Chapter 2: Energy Matters: Energy Price Shocks and the Global Economic Transformation....................................................................... 25 Chapter 3: Global Energy Mega-Risks: Resource Depletion, Geopolitical Security, and Climate Change............................................. 43 Chapter 4: Why Private Organizations and Markets Fail......................... 67 Chapter 5: Can Our Governments Act Pre-emptively?............................ 83 Chapter 6: Can Our Governments Forestall Climate Change?............... 103 Chapter 7: Looking Forward..................................................................115 Notes................................................................................................... 129 Bibliography........................................................................................ 151 About the Author................................................................................. 157

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Preface This book is about whether our society, specifically North American society (the United States and Canada),1 has the decision-making capabilities that would allow it to take pre-emptive action to prevent a crisis. This is not about being blindsided by that which simply cannot be known. But if we can foresee disaster looming, not with certainty but with some reasonably high probability, can we make provisions to alter course in any fundamental way? Simply put, can our private or public institutions be prudent in their behaviour—not in what they say, but in what they actually do? Or must we drive forward until the crisis befalls us, before we can act in any material way? I will argue that our institutions are designed in such a way as to make prudent behaviour highly unlikely.2 Their almost exclusive purpose is to maximize economic growth, preferably with low levels of unemployment. In pursuit of this objective, they are designed to encourage risk-taking, to avoid tough decisions, and to deal with the consequences later, if they arise. Lack of knowledge of risk is not the problem. The problem is embedded more deeply in our institutional architecture. That is, the compulsion to proceed, no matter the risk, is dictated by the values, rules, and organizations (public and private) that comprise our society. Accordingly, we must wait until a problem that is now on the horizon, or just over the horizon, becomes a widely recognized “clear and present danger” before we act.3 The review here of the decision-making capabilities of our dominant institutions—markets, private corporations, households, and federal governments—has import for any policy decision. But I will use energy policy issues as my primary example. As we shall see, energy—because of its essential role in human life and its overwhelming scale of use in modern complex civilization—elevates what is being decided upon to a global and existential level. Our entire experience of economic growth under market capitalism, although brief, has been made possible by our access to fossil fuels. When something goes wrong with our energy supply (including food, which is simply energy fit for human consumption), it has a profound and negative macroeconomic impact on North American society, even though we are also very large energy and food producers. The negative impact increases the more a society depends on importing these vital energy commodities. So

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some societies are far more vulnerable than our own. If, however, something went horribly wrong, it could rock our now global civilization to its very core. The only question would be whether our institutions could survive the quake still standing. Their very existence would be threatened. Such global energy-related crises are, in fact, somewhere in our future. There are three that I identify: repeated energy price spikes related to resource depletion; resource wars; and the ultimate problem of radical climate change bringing with it droughts, rising oceans, and more violent storms. These crises are all global in scope and potentially existential in their impact on society. Each is deeply complex; elements of uncertainty are therefore inherent. For example, each could manifest in unanticipated ways or even “go viral” and spin out of control. While no one can predict when one of these risks will manifest itself as “a clear and present danger,” there is little scientific doubt that it will happen. It is as if we were living on the Titanic and rushing headlong into iceberginfested waters. Our captains know there are icebergs ahead. But they do not know precisely where the icebergs are or how large. And the icebergs could be shrouded in fog, even as we get closer. Can reason and fact be our guide? Could we even slow down? Typically, we like to believe so. Our model in this belief is the enormous success of the physical sciences which are, for the most part, based on reason and fact. Yet, as I will argue, that is not at all how our political marketplace works, nor how some of our most important private institutions work. If our captains have an incentive not to interrupt our contented sleep or our happy partying on their watch, then we will sail relentlessly forward into dangerous waters. In fact, our society in general is not designed for prudent action. It is designed for economic growth—to keep the national growth party and the global growth parade going at any cost. And as for the risk involved in this collective enterprise, we privatize upside reward and socialize downside cost on a wide and pervasive scale. A highly insured society should be a highly regulated society. We, however, offer social insurance even as we deregulate. Both ends of the political spectrum are responsible. Accordingly, this approach is a potentially fatal design flaw in our societal decision-making processes. Economists call it “moral hazard.”4 Closely related is the concept of an “externality,” in this instance a negative externality. Essentially, in risky situations, the key decision makers reap the benefits but do not bear all the costs of their decisions if they turn out badly. Such a design helps to make our society more dynamic. That is its strength. It has raised our society up out of subsistence living and made possible our current standard of living. But equally it exposes society to potentially catastrophic consequences. I will argue that this design flaw is everywhere in our society. It is embedded not just in the limited liability and social insurances granted our corporations and households, but also in the operation of our governmental

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institutions. Our federal governments suffer from systemic weaknesses that give rise to declining public trust. This distrust makes it difficult, if not impossible, for governments to lead on the basis of forecasts. Governments also suffer from a related paralysis brought on by a deep ideological divide operating in the context of a tightly constraining system of political checks and balances. Those checks and balances include the federal structure of North American governments, which reflect profoundly different regional economies and energy resource bases. As a result, all difficult political choices are punted into the future—a future that does not get a vote. The only exceptions are choices made in response to “a clear and present danger.” These design flaws have been accentuated by the recent renewed growth in income inequality and the correspondent growth in financial debt in our society. Income and wealth inequality and the associated rising financial debt ratios are directly related to global energy economics, specifically the rise of the coal-based, labour-intensive economies of Asia and the labourdisplacing technological response it has inspired in North America. These global market forces have impoverished many North American households and increased their debt loads, and now will serve to make our society even less prudent. High debt-to-income ratios increase risk by increasing the vulnerability to negative shocks such as spiking energy prices. They also increase the political pressure to speed up economic growth as the only painless way to pay down the debt obligations. We not only hope for the best in the future, we need the best. That is not prudent, by any definition.5 The final chapter of the book attempts to look ahead. My presumption is that we have no capacity to change our institutions from within. We cannot fundamentally change public policy without changing the institutions responsible for making it. But these same institutions would need to have an ability to change their own essential character. This is highly unlikely. We are, in a very important sense, trapped by our ideas and will pursue them diligently until they are overthrown by events. For some, this is far too gloomy a prospect. But it need not be so. The end of one regime means the beginning of another. One must be ready with the redesign program in hand when the occasion presents itself. The new social architecture is unlikely to be merely a marginal tweaking of the ideas that brought society to this point. Hence there is much work still to be done. But this work cannot usefully proceed without a clear understanding of where we are and how we got to this condition.

The Organization of This Volume This book is intended for a non-expert audience. Accordingly, the first few chapters will review the brief history of economic growth, the role of energy, and how and why we govern our society as we do. These institutional characteristics must be understood before one can answer the central question of this volume, “Can our institutions act with prudence?”

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This book also focuses primarily, although not exclusively, on the economic development and political institutions of the United States. The United States of America has the world’s largest and richest economy, and for the past hundred years or so it has been the technological leader of the global economy. It is also a military superpower, so far unmatched by any other nation or group of nations. The energy problems the world now faces are global matters and require global leadership. It makes the most sense to focus on the United States as potential leader. It will have the greatest weight in the councils of the world. The issues addressed in this book are also relevant to the question of the continuing future global supremacy of both the economic and military establishments of the United States. Canada gets less attention because there is great similarity in the geography, cultures, and economic organizations of Canada and the United States. We share the same continent, isolated by distance and oceans from the larger populations of Europe and Africa and the vastly larger populations of Asia. We have similar levels of economic development, and our two economies are deeply integrated by trade, investment flows, and corporate ownership. This interdependence has only increased as a result of the Canada-U.S. Free Trade Agreement and the subsequent North American Free Trade Agreement. The Energy Chapter of those agreements made the Canada-United States energy industry even more integrated on a north-south basis. While there are institutional differences between Canada and the United States, there are more important similarities. Both countries have representative democracies and federal structures governing a vast geographic area, comprising very diverse regional economies. The essential dynamics of the political marketplace is the same in both countries. And both countries are major producers of all forms of energy, although again the United States dwarfs Canada’s production in every category, except hydroelectricity and uranium. Both countries also share the same global energy security interests. And, in a now global marketplace, no North American household or corporation has escaped the profound implications of changing global energy economics. Accordingly, this volume is organized as follows: • Chapter 1 outlines the comparatively brief history of economic growth (defined as growth in income per worker or per capita); • Chapter 2 explains how the energy price spikes of the 1970s and again in the first decade of this century have profoundly altered our now global economy and made the Western economies more, not less, vulnerable to further such spikes; • Chapter 3 describes the future potential for energy price spikes related to both resource depletion and resource wars as well as the property and life-destroying impacts of radical climate change; • Chapter 4 describes when and why private corporations and households fail in respect of the energy mega-risks;

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• Chapter 5 describes why governments fail to prepare for future energy price spikes related to resource depletion and resource wars; • Chapter 6 outlines why Northern America’s federal governments cannot act to forestall potentially radical climate change; and • Chapter 7 speculates on what might be in our future.

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Chapter One

The Brief History of Economic Growth Economic growth is a central part of the story of human development, not to mention a central preoccupation of most citizens and their political leaders in modern societies.1 Yet it has a comparatively brief history, perhaps 200 to 250 years compared to the roughly 5,000 years of civilization or the 10,000 years since some human societies invented agriculture to substitute for hunting and gathering. This chapter tries to capture the highlights of this brief history. Understanding how this journey began, its compelling internal logic as well as its institutional paradoxes, plays an important role in setting the stage for our current predicaments and in addressing the central question of this volume. Can our institutions act with prudence when confronted with uncertain, but potentially calamitous, futures?

The “Dismal Science” Imagine yourself travelling across a seemingly endless flat terrain. Your tribe has travelled for thousands, even tens of thousands of years, and nothing much changes. You cannot see ahead, but to some degree you can see what is right around you. You trust the elders to know where you have been. There is the flat sameness always and everywhere. Then suddenly, seemingly out of nowhere, you are on a precipitous upward climb. When you glance back, you are looking down a steep mountain wall. This is what the human experience of economic growth has been like. We have now risen far up from the endless flat plain where our ancestors dwelled for thousands of years. From this vantage point, we can see that most humans were no better off in 1800 than they were 100,000 years earlier!2 Of course, people wore different clothing, spoke different languages, and had different customs. But until about 1800 or even 1820, the vast bulk of humanity, no matter where they lived on the planet, could not escape a subsistence level of income. In short, for thousands of years there was no discernible growth in income per capita—it was fixed at subsistence.

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The English economist and reverend Thomas Malthus, writing in 1798, regarded this fact as an inevitable state of affairs. In “An Essay on the Principle of Population,” he hypothesized that any increase in average human welfare would always be swallowed up by an increase in human numbers. For he observed that population increased at a geometric rate, whereas land—the source of food supply—would at best increase at only an arithmetic rate.3 Since people procreate so much faster than the increase in arable land, each additional farm labourer, effectively working with less and less land, would add less and less to the total output. Ever more labour crowding onto the very slowly increasing supply of arable land would result in diminishing returns. This iron law ensured that food production could not keep pace with population growth. In Malthus’s view, the working class would always breed itself back down to a subsistence income.4 In Malthus’s model, the only limit on population was food supply. Thus if the birth rate was uncontrolled, then the death rate must be the equilibrating factor. When the population overshot the land’s carrying capacity, then mega die-offs in the form of famine, disease, and war would exact their brutal toll. Now this was an ominous forecast! Yet it largely fit the evidence to that point in human history. For his dire prognosis, the Reverend Malthus earned for economics the appellation “the dismal science.” Who could protest such a charge? It was not only a trap, but also one that repeatedly brutalized and ensnared humanity, with no prospect of sustained relief. No act of charity would alter the inevitable. No public policy could avert the ultimate outcome.

Free at Last: Welcome to the Party! The Malthusian trap is real enough and still haunts some nations, particularly in Sub-Saharan Africa.5 But the dismal forecast did not happen in England; in fact, just the opposite happened. Rather suddenly, a mere 200 to 250 years ago, starting in England, some societies took off into a process of industrialization and self-sustained economic growth. It was nothing short of a revolution—the Industrial Revolution—that resulted in higher income per capita that was not only sustained, but actually increased over time. In less than a hundred years, the real per capita gross domestic product of Western European countries almost tripled from $1,202 in 1820 to $3,457 in 1913. It had taken the previous 1,820 years for these economies to roughly double income per capita from $576 in AD 1 to $1,202 in 1820.6

Economic Growth and Urbanization of Population Even more astounding, humans accomplished this recent spectacular increase in real per capita income while accommodating a vast increase in population.7 It had taken many thousands of years for the human population to reach roughly 226 million in AD 1.8 Eighteen hundred and twenty

Chapter 1. The Brief History of Economic Growth  3

years later there were still only around 1 billion people. By 1950, a mere 130 years later, there were 2.5 billion people, and it took only 60 years to reach 7 billion people today. This modern population is highly urbanized. Until 1800, by far the largest part of the world’s population worked in agriculture and lived in rural settings with relatively low population density. In 1800 only 3 percent of the world’s population lived in cities. The Industrial Revolution changed all that. Now, over half of the global population lives in urban centres (52.1 percent).9 There continues to be a mass migration of people out of subsistence farming into large, densely populated metropolitan areas, indeed into megalopolises of tens of millions of people. Today, there are 449 cities with 1 million or more inhabitants and 23 with 10 million or more.10 Roughly 78 percent of the developed world already lives in urban areas; the ratio is higher in some post-industrial countries such as the United States, United Kingdom, France, and Canada.11 These urbanites live in buildings made of steel, glass, cement, aluminum and plastic, all materials that are heavily energy-intensive in their manufacture.

Food Energy and Agricultural Productivity Underpinning and facilitating this increase in population and urbanization was a spectacular increase in agricultural productivity. Food itself, of course, is simply energy in a form that is edible to humans. In fact, the discovery of agriculture was humanity’s first big energy breakthrough. The growth in our production of food energy, and our ability to store it, rests at the core of the entire modern economy. It is not possible to specialize in any non-food-producing activity unless those employed in food production produce more than they themselves need. The growth of specialization, governments, markets, and cities all depend fundamentally on the productivity of agriculture. Modern agriculture is, in turn, among our most productive, but also among our most fossil fuel intensive industries. Its spectacular increase in productivity has been based largely on three things: vastly expanded use of farm machinery powered by gasoline, diesel fuel, and electricity; fertilizers and pesticides made from natural gas and oil; and improved crop varieties. Today’s crops are derived from the science of genetic engineering, which after millennia of trial and error has moved from the field to the industrial laboratory where experimentation is aided by superfast computers. Mechanization and increased farm scale have released much of the remaining labour force to find other productive employment. Today, the agribusiness, as with other energy-producing businesses, is dominated by global corporations. They have largely replaced small-scale family farms and food processors. In the United States, less than 1 percent of the population produces enough to feed all the rest.

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Tools and Energy Obviously, Malthus had left something vitally important out of his theory. Among other things, what he left out was the impact of technology on productivity.12 Presumably he did so because it was not yet evident to him, or to other writers living around 1800, just how dramatic the effects of technology could be. Moreover, the new machines that constituted the essence of the Industrial Revolution were powered not by humans or animals, or even by wind or water, but increasingly by coal.13 Specifically, multiple applications of the steam engine lay at the core of this relatively sudden increase in human productivity. Increasing returns, not decreasing returns, prevailed. The implications were nothing short of earth shattering. Energy is defined as the ability to do work. Tools can be defined as instruments that direct energy to its greatest effect.14 It is in these acts—acquiring and directing energy—that we humans have been able to order our world to our preferences. Our gross domestic product (GDP) is nothing other than a numeric representation of our ability—using animate and inanimate energy combined with tools—to transform our environment into the things and services we want and value. Our income is, in a very real sense, a reflection of our power, our access to and control over energy. Accordingly, wages are simply a partial reflection of the food-energy cost required to power human capital. But, of course, humans do not live by food alone. They need clothing, shelter, and utensils, not to mention entertainment and other services. No matter. Every product that a household consumes, whether or not it is directly an energy source such as gasoline, electricity, heating oil or natural gas, is ultimately reducible to an energy cost associated with the making of that product or service. Indeed, people’s incomes whether measured in wages or interest, dividends and rents, when compared to the prices of the goods and services available to them, can be thought of as the amount of energy that they have at their command. Their income represents their ability to transform their environment into the things and services they want. The higher their income, the greater the energy at their disposal, and the greater their command over their environment. Economic growth therefore represents our collective increase in power, our collective increase in control over energy. To be poor is, quite literally, to be almost powerless. In fact, I would argue that the co-evolution of tools and access to energy is the defining characteristic of human evolution as a species. More than anything else, this is our story. You might say not only that “Tools R Us” but also that “Energy Is Us.” To possess one without the other is meaningless. What good is even the most complex machine without the energy to power it? And of course humans cannot survive without food energy.

Chapter 1. The Brief History of Economic Growth  5

Specialization, Markets, and Tools Essentially, modern economics as a discipline originated in the attempt to answer the question, Why do nations grow rich? In 1776, on the eve of the Industrial Revolution and on the birthdate of the United States, Adam Smith published The Wealth of Nations. He pointed out the degree to which specialization facilitated a vast increase in productivity as well as product quality. He was aware, however, that it was not possible to take the concept of specialization very far, unless one could exchange one’s product for other things needed for life. In short, specialization is limited by the extent of the market, the opportunities for exchange. And it is not true just for people—human capital—it is also true for tools. More specialized machines are more productive. Accordingly, big, and then even bigger, domestic and international markets are centrally important. It was David Ricardo in his Principles of Political Economy in 1817 who first demonstrated that not just individuals but whole countries are better off to specialize, even if they are superior to their trading partners in the production of everything. This is the remarkable principle of comparative advantage. Most people still do not appreciate the degree to which these fundamental insights govern our social structure, only now on a global scale. Nonetheless, while specialization and big markets serve to increase human productivity, diminishing returns must still prevail once all countries are engaged in trade and the optimum degree of specialization has been attained. Nor does the simple accumulation of more tools—more capital assets—as productive as they may be, forever attenuate the law of diminishing returns. David Ricardo, a friend of Malthus, and both a brilliant economic theorist and a successful financier of the day, was first to point to the problem. He saw that even capitalists would ultimately come to no good end.15 For Ricardo, as more capital was employed, it would require more workers. That would be no problem. As the number of workers grew, however, ever less productive land would be drawn into use, raising the price of grain relentlessly. Wages would then be forced up so that workers could buy enough food for their subsistence. Accumulate capital as they might, therefore, the profits of capitalists would be eaten up by competition and by ever higher wages. Workers would be no better off, and neither would capitalists! In the end game, those with the very best grades of arable land would be the only real winners. This is notwithstanding that in Ricardo’s view they were the least responsible for the progress of society. Ultimately, the resource constraint of productive agricultural land, the same old trap, would reassert itself. Why then has this not happened—at least so far?

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Not Just More But Better Tools The advent of continuous economic growth was not just about the use of specialization, markets, and tools. All had been used extensively, and had slowly improved, over thousands of years. But specialization and trade confer one more remarkable benefit. They increase knowledge and help to spread it across human societies. Humans imitate the tools and techniques of others, even other animals (as in learning how to fly). Trade and larger markets also allow for further technological development through trial and error and learning by doing. Inventors “tinkered” with their machines to make them better and to find new applications. Large markets mean large production runs; the more we practice, the better we get. Specialized technical knowledge can also be written down and passed on in a reasonably precise fashion. The invention of Gutenberg’s moveable type printing press in 1439 was a profound breakthrough. He printed his first book in 1455. By 1500 there were 220 printing presses in Western Europe, and they had produced 8 million books.16 Science, and the scientific method based on reason and fact, would begin to flourish.17 At the turn of the millennium in 1000 there were no secular universities; by 1500 there were 70.18 The continued development of modern science and mathematics became central to the development of better tools. Indeed, technological innovation would eventually become the primary purpose of private science-based research and development activities. Accordingly, our modern understanding of economic growth now focuses first and foremost on the development of better tools—that is, on technological innovation. It is not a matter of simply copying someone else and then building a competing factory. Developing new technology itself— building a better mousetrap—becomes the essence of market competition. Joseph Schumpeter, an American raised and educated in Austria whose writings spanned the 1920s to 1940s, is credited among economists as being the central scholar in pointing to the dynamic contribution of new technologies (new tools) to economic progress in a process of “creative destruction.”19 He was not much concerned with the static “efficiency” of competitive markets—a traditional concern of economists. For Schumpeter, economics was about more than just how to get the most valued output from a given resource base. The competition that truly mattered was the dynamic competition from new commercial ideas and new technologies. He went so far as to argue that technological change was enhanced by both large-scale enterprises and temporary monopolies. Schumpeter’s mega corporations were not nameless, faceless, private bureaucracies. They were animated by entrepreneurs with vision—men like Henry Ford, John D. Rockefeller, Thomas Edison, and Cornelius Vanderbilt. They find their modern equivalents in Bill Gates, Steve Jobs, Larry Page, and Mark Zuckerberg among many, many others. Moreover, embedded

Chapter 1. The Brief History of Economic Growth  7

in the modern concept of innovation is not simply the idea of a marginally better tool, but something potentially transformational. Examples would include the steam engine (which begat the locomotive and the steamship), electricity (from the discovery of the electromagnetic force, which begat the electric motor, the dynamo, the telegraph, the electric light, the telephone, the radio), the computer (which begat computer-assisted design and machines, robotics, and the Internet), and the internal combustion engine and jet engine (based on oil, which begat the automobile, the airplane, and mass production). Many other technologies in materials science and chemistry and biology and a host of other areas had to be invented as well. There is no question of the explosive quality of invention and innovation that marked the nineteenth and twentieth centuries. And such innovation could be profoundly disruptive, with impacts on the established economic, and possibly political, order. Our tools define our society, as the brilliant Canadian scholars Harold Innes and Marshall McLuhan so clearly understood.20 Changes in tools change society. Some economists have even built theories of business cycles based on periodic bursts of inventive and innovative activity—often around a core transformational technology.21 A multitude of other researchers have since explored this fascinating territory. The exact institutional setting—large versus small enterprise; global versus domestic enterprise; diversified versus narrowly focused enterprise; manufacturing versus service versus resource-based enterprise; monopoly or oligopoly versus contestable markets; government defense research versus private research establishments; universities versus private enterprise—that might be the wellspring of new technologies is still debated. Some believe that commercial innovation, because it involves so many different skills, is best stimulated by a “critical mass” of creative people—inventors, entrepreneurs, venture capitalists, investment bankers—clustered in certain geographic locations and each bouncing ideas off one another.22 Suffice it to say here that the proximate motive for new technology, aside from technological curiosity, is money. A successful innovation can scale up dramatically to be worth a fortune to its owners. Unlike a movie blockbuster or a global bestseller, however, it can be worth not just tens of millions or even hundreds of millions but billions of dollars to its owners. Such is the power of new ideas and new products when coupled with global markets and multiple potential applications. Selling the same concept or idea, over and over again, even though it cost nothing to replicate the basic idea, is the secret to a vast and almost instantaneous fortune. The key is to get possession of that idea and then, of course, to have access to the global marketplace. The prospect of becoming a multibillionaire continues to entice the best and the brightest, who often make many, many other millionaires in the process.

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No Resource Limits? There is obviously some physical limit to how many humans can crowd onto the planet. It would be very uncomfortable, not to say impossible, to find ourselves standing shoulder to shoulder everywhere. But there is no known limit to the human capacity to transform our environment through the use of energy and tools—that is, through technological innovation. Yet this is just another way of saying that there is no limit to our capacity to grow richer—in income per capita terms.23 It might not be wise or even desirable, but continuous economic growth can, in principle, be sustained by the “creative destruction” of technological innovation. It is this process of technological innovation that is thought to be an inherent part of the socio-political-economic system that is modern market capitalism. Private firms engage in research and development, constantly improving their technologies and looking for the next big blockbuster application. The legal structure of society rewards research and development (with monopoly returns provided by patent protection).24 But the patent process itself reveals information and assists competitors and imitators. What if the in-house research laboratories of global corporations fail to produce new technologies? No matter; their managements are constantly on the lookout for small companies with proprietary technologies to acquire. The global enterprise by its very structure and its “brand name” has access to the entire world economy, typically with production facilities or at least contract suppliers in each major global market. Global corporations are constantly acquiring their technically advanced but financially smaller, upstart brethren. This model, albeit with many refinements, is now the dominant model of modern economic growth.25 Investments in information technologies from the first invention of writing to the invention of the printing press, the telegraph, the telephone, the radio, the television, and the Internet have all served to expand the sharing of knowledge and information. These investments have profoundly shaped and reshaped our institutions. And all have acted simultaneously to increase market size and further technological change. Similarly, investments in transportation technologies—from the four-mast sailing ship to the locomotive, to the steam ship to the truck to the airplane, to the high voltage transmission line and pipeline—have greatly expanded markets and have had positive feedback effects on production economies of scale. Knowledge does another remarkable thing: it pushes back the frontier of resource constraint. For example, if arable land is the key constraint, then with enough knowledge we can and do reclaim land from the sea or desert. Or if we cannot create more land, we can make the existing land more productive by adding fertilizers, accessing deeper aquifers, preventing soil erosion, changing our plowing techniques, and rotating crops. At the beginning of the twentieth century, two German scientists would develop the Haber-Bosch process to produce ammonia from hydrogen and

Chapter 1. The Brief History of Economic Growth  9

nitrogen. Until that point the depletion of nitrogen in the soil was the dominant constraint on the growth of agricultural output. Fertilizers made from natural gas changed all that. Later it was possible to bioengineer the crops to grow on less productive land, using less water. Fertilizers, pesticides, and improved crop genetics gave rise to the Green Revolution. Suddenly, all inputs can scale up. There are no diminishing returns because there are no inherently fixed resources—provided that our technology keeps coming to our rescue! And this, as we shall outline, includes our access to primary energy.26 Not everyone, of course, believes that new technology will always come to our rescue.27

The Great Western Leap Ahead: Global Income Divergence The countries of Western Europe, the United States, Canada, Australia, New Zealand, and Japan were the prime industrial movers. England was first off the mark, but by the 1880s the United States was leading the pack. These were capitalist economies where the creation of more and better tools was primarily undertaken by privately owned, for-profit enterprise.28 Capitalism and the process of industrialization were so profound in their impact on productivity that these few advanced “Western” economies left the other countries of the world far behind in terms of their relative income per capita. It was the period of the “Great Global Income Divergence.” This leap ahead of all other nations was even more spectacular because, after the collapse of the Roman Empire, European incomes had fallen. For centuries, Europeans were no better off, and perhaps worse off, than Asians or anyone else in the world. Their share of global income was roughly equal to their share of global population. Things began to improve as feudalism slowly faded. By 1700, Western Europe and its colonies in North America (plus Australia and New Zealand) had 13.8 percent of the global population and 22.1 percent of global GDP. By 1820, their shares had increased slightly to 13.9 and 24.9 percent, respectively. By 1973, however, these same countries had 15.6 percent of global population but 50.9 percent of global real GDP!29 For many of us living in North America, when we think of history, it is this short history and these few leading industrial nation states that we have in mind. Whatever these societies were doing that was different, it served to make them far richer than the rest, for better or for worse.

England and Coal There are many proximate explanations for why the Industrial Revolution occurred first in England before spreading to continental Europe and North America—everything from favourable demographics and political institutions to favourable colonial relationships and religious beliefs. Whatever the exact recipe, England obviously possessed a necessary and sufficient set of

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ideas, beliefs, and organizations for an industrial revolution to get underway in the period from about 1750 to 1850. But there is something else that England possessed—something equally vital—coal, an abundant and cheap source of energy to run the new tools. The inescapable physical reality is that machines, no matter how supersophisticated, can do no work—and therefore produce no output or income—without energy to power them. The Industrial Revolution that has so transformed some human societies was made possible only because these societies tapped into, and directed ever more effectively, the vast storehouse of energy that coal represented in the nineteenth century and that coal, oil, and later natural gas and nuclear energy represented in the twentieth. The availability of coal was a central element in England’s Industrial Revolution. Wood was the principal fuel source in feudal England, as it was elsewhere in Europe and North America at that time. But by the eighteenth century most of the forests in England had been cut down. Accordingly the price of wood began to rise and provided the incentive to find a substitute fuel. England had ample supplies of coal. But as the easily accessible surface coal was used up, the mining operations were forced to go deeper into the earth’s crust and accordingly became more complex. A major problem was keeping water out of the deeper mines. Along came Thomas Savery in 1698 and Thomas Newcomen in 1712 with the steam engine, designed specifically to suction water from coalmines. But it was not just the scarcity of wood per se that led to the steam engine; it was also the high price of human labour in England. At that time, English wages were higher than they were in continental Europe.30 The alternative to the steam engine was pumping by hand. High wages gave English entrepreneurs an added incentive to use machines to displace manual labour. The early steam engine was hopelessly energy inefficient by later standards. But it existed and it worked. It was to fall to James Watt in 1768 to take the critical next steps to improve the reliability of the technology and make it commercially more viable—that is, more energy efficient. As the price of coal rose, so did the incentive to improve the technology. Other inventors followed, making continuous improvements to the basic engine. Equally important, later inventors introduced many more applications. England, indeed the world, would never be the same. The railroad and the steamship among many other inventions would propel Western economies forward. Distance would shrink in importance. Markets would get bigger as a result. The first Industrial Revolution could literally “pick up steam.” Even to this day, the burning of coal to produce heat, to boil water to make steam to drive a turbine connected to a generator, is a core technology in the production of electricity. Coal freed industry to go to more convenient locations away from running water and water mills. It was also essential in making coke for use in

Chapter 1. The Brief History of Economic Growth  11

blast furnaces, which lowered the cost of iron. Iron in turn was an essential material for more tools—everything from locomotives to railroad tracks to iron steamships to bridges. Iron would later give way to the greater tensile strength of steel, capable of being mass produced in the second half of the century. But coal remained an essential input, even to steel—the quintessential modern industrial material. England, the birthplace of the Industrial Revolution, had plenty of coal. As a matter of historical record, England exported coal to continental Europe where coal was more expensive at the time. But could an industrial revolution have occurred in England at that time, without coal? Not likely. The English could not have invented their way around the absence of a new energy resource. Wood supply was increasingly depleted, not only in England but in Western Europe generally. Square timber for masts, a strategic commodity for England’s Royal Navy, already had to come from the Canadian colonies—with the assistance of preferential tariff treatment, an early example of energy security policy in action. Of course if England did not have coal, it might have imported it. After all, Japan—that other would-be island empire builder—began to industrialize almost a century later with a very limited indigenous energy supply. But it would have been logistically difficult and hugely expensive to transport large quantities of coal from continental Europe to England in the eighteenth and early nineteenth centuries. Moreover, it would have been strategically dangerous, as Japan would discover in the next century. Napoleon tromped all over Europe from 1803 to 1814. England had to solve the energy problem closer to home. Fortunately for the English, the matter was academic; geology was on their side.

Jevons’s Forecast The central importance of coal to England’s industrial success in the nineteenth century was not lost on contemporary society. No less acute an observer than William Stanley Jevons, an early economist of considerable note, in 1865 wrote The Coal Question: An Inquiry Concerning the Progress of the Nation and the Probable Exhaustion of Our Coal Mines. It begins, Day by day it becomes more obvious that the Coal we happily possess in excellent quality and abundance is the mainspring of modern material civilization. As fuel—or the source of fire—it is the source at once of mechanical motion and of chemical change. Accordingly, it is the chief agent in almost every improvement or discovery in the arts which the present age brings forth.31

Jevons was convinced, based on the best geological evidence available to him, that domestic coal in England would soon run low in quantity and quality. Accordingly, its price would inevitably rise, thereby forcing England to yield to other industrial powers. He thought the United States with its vast Pennsylvania coal fields was a likely candidate.

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The countries of northwestern continental Europe also possessed coal or had ready access that could power their own industrial revolutions. In 1910, for example, coal prices in Germany, Belgium, the Netherlands, Denmark, and Poland were below those in Britain.32 Jevons was proved by subsequent history to be wrong about England’s coal supply, and the potential for substitutes; but the new powerhouse economy was, as he had predicted, the United States.33 The states bordering on the Great Lakes would become the home of North America’s manufacturing heartland—the industrial wonder of the world. The local availability of coal played a strategic role in the rise of the Great Lakes region. Southwestern Ontario, Canada’s industrial heartland, was an integral part of this unique geographic space. For the next hundred years, the Great Lakes economic region would dominate global manufacturing. This region would only truly be displaced by the rise of yet another manufacturing superpower based on coal—the Asia Pacific, principally China. In the twentieth century, the United States clearly emerged not only as the richest and most technologically advanced capitalist economy in the world, but also by the end of that century as its only military superpower. The last hundred years have easily deserved the label “the American century.”

Energy and the Rise of an Industrial Superpower Figure 1.1 shows the history of U.S. energy use, by energy source. The U.S. economy did indeed propel itself to the first rank among industrial nations on the basis of coal. Only oil and then later natural gas would come to be more important. The American civil war had raged on from 1861 to 1865. In 1869, however, the first transcontinental railroad was completed, signalling an opening step in the creation of a massive continent-wide economy. The steel industry used huge quantities of coal (two tons of coal for every ton of iron ore) and came to be located close to that coal south of the Great Lakes.34 Steel rails facilitated the opening of new markets and new territories in the interior. Enormous tracts of agricultural lands were opened up. Food energy then headed east on the rails to feed city workers while their manufactures headed back west. To indicate the sheer scale of railway construction and market expansion taking place in the United States at that time, consider that between 1850 and 1910, the amount of completed rail went from 9,000 miles to 352,000 miles of track! The comparable mileages for Britain were 6,100 to 20,000; Germany, 3,600 to 38,000; France, 1,800 to 25,000; and Russia, 300 to 41,000 miles of track.35 What distinguished the United States from the competing Western European economies was not differences in its core institutions. Those were largely modelled on the political and economic institutions of Western Europe itself, principally England and France. What was profoundly different

Chapter 1. The Brief History of Economic Growth  13

FIGURE 1.1 U.S. Primary Energy Consumption Estimates by Source, 1775–2011 45 40

Quadrillion Btu

35 30 25 20 15 10 5

17

75 17 8 17 2 8 17 9 96 18 0 18 3 1 18 0 1 18 7 24 18 3 18 1 3 18 8 4 18 5 52 18 5 18 9 6 18 6 7 18 3 80 18 8 18 7 94 19 0 19 1 08 19 1 19 5 2 19 2 2 19 9 36 19 4 19 3 5 19 0 5 19 7 64 19 7 19 1 7 19 8 8 19 5 92 19 9 20 9 06

0

Petroleum  Nuclear Electric Power 

Coal  Wood 

Natural Gas  Other Renewable Energya

Hydroelectric Power

Note: a Geothermal, solar/PV, wind, waste, and biofuels. Source: Adapted from colour from U.S. Energy Information Administration, Energy Perspectives 2011, Chart 5, 27 September 2012, http://www.eia.gov/totalenergy/.

was that the United States possessed a huge, rich, and continent-wide domestic market, as well as enormous reserves of domestic energy resources. Moreover, it was protected by vast oceans and not threatened by its bordering neighbours. These advantages gave the United States eventual primacy over its closest rivals.

Electricity At the same time, the fundamentals of electromagnetic energy were being worked out and the electric motor, electric light, and the dynamo to produce electricity made an appearance. The telegraph and the telephone became a central part of a vast continental communications network. In terms of commercial invention around electricity, no name stands out more brightly than that of Thomas Edison. Edison’s electric light bulb replaced oil lamps for lighting. Coal and water power would be used to generate the electricity. Electricity was so useful a form of energy that it soon came to be synonymous with modern economic development. At first the demand for electricity was limited to only the few. But economies of scale in its production and the switch from direct current to alternating current (thanks to George

14  Navigating on the Titanic

Westinghouse) in its transmission and distribution, along with improvements in metering, led to sharply lower costs and prices. This development was further enhanced by the recognition that electricity production, transmission, and distribution were best organized as a “natural monopoly.” Very large-scale power plants would generate the electricity and then it would be transmitted and distributed over a vast network of high and lower voltage wires to factories, businesses, and homes.36 But a monopoly, of course, required price and quality regulation by an independent entity to ensure that both customers and monopolist were treated fairly. It would not be until the 1980s and 1990s, particularly with the development of natural gas–driven turbines (an extension of jet engine technology) that the term “natural monopoly” no longer seemed appropriate to describe the generation of electricity. As a result of all these factors, the market for electricity grew even faster than the economy and even included the transportation sector, such as trolley cars. Modern factories and, after the Second World War, all homes and eventually all farms became totally dependent on electricity. Even today, in advanced capitalist economies the demand for electricity closely matches the increase in income. In developing countries, demand growth for electricity typically exceeds the growth in income.

Oil But perhaps nothing heralded more clearly the “American Century” of global dominance than the story of oil and the internal combustion engine.37 As it happens, in 1859 oil had been discovered near Titusville, Pennsylvania. This was a portentous event. Oil would not only fuel the emergence of the United States as the world’s largest and most dynamic economy, but also allow it to become the world’s foremost military power. Until the twentieth century, and as illustrated in Figure 1.1, the oil industry was still in its infancy, although its distillate kerosene steadily replaced whale oil in the lighting industry. Still, this market niche in lighting was enough to create an important emerging industry and eventually one of the world’s most formidable enterprises—Standard Oil of New Jersey, the company assembled by John D. Rockefeller. The critical invention, however, for the future of oil had already been exhibited at the Paris Exposition of 1867—the world’s first internal combustion engine invented by Dr. N. A. Otto of Germany. It did not take long before such engines were in widespread use and their horsepower was rapidly scaled up. Gasoline, a byproduct of kerosene production from oil, was to become the fuel source of choice. The first automobiles were produced in the United States in the 1880s; by 1905 there were 121 establishments making them. It was Henry Ford who turned the automobile into a mass consumer product, supplied by mass

Chapter 1. The Brief History of Economic Growth  15

production techniques. In doing so, he too would demonstrate the power of specialization and economies of scale. In 1907/08, Ford produced 6,398 cars at a price of $2,800 (Model K). By 1916/17, Ford produced 730,041 cars at $360 each (Model T).38 The automobile industry, and the oil industry, would soon dominate and become almost synonymous with the American economy and the best interests of the entire society. The requirement for large-scale production dominates the oil industry, just as in the production of electricity and automobiles. Almost every aspect of the oil industry, from field development to production, transport, refining, storage and distribution exhibited declining average costs when the scale of the activity was increased—economies of scale. As noted above, economies of scale dominate virtually all aspects of the energy industry to this day. So does a preoccupation with risk, since along with the gargantuan scale and cost of energy projects comes an equal or greater risk. No risk is perhaps more complex than political risk—of confiscation or nationalization by local governments, political breakdown of the local regime, acts of terrorism, or indeed acts of war. Energy resources fuel all such possibilities. Oil, especially, would come to play a strategic role in warfare—to power battleships, trucks, jeeps, tanks, and aircraft. And the United States, as the world’s largest producer of both oil and the machines of modern war, would soon establish itself as the world’s foremost military supplier as well as military power.

War and Energy Security The ability to make war was vastly enhanced by market capitalism, and the motives for war were enhanced as well. From 1850 to 1913, an aggressive imperialistic competition to find both raw resources and new global markets marked the early relationships among the leading industrial powers. Then suddenly, seemingly out of nowhere, global war erupted. A mere 20 years after the First World War ended, the Second World War began. World war produced casualties, both soldiers and civilians, on a previously unimaginable scale. Huge amounts of energy were released in its most destructive forms. Energy was used to tear down buildings, blow up machines, and destroy life rather than to create and sustain it. In the First World War, tens of thousands of soldiers on both sides died in a matter of days as a result of machine guns and artillery bombardment. In the Second World War, entire cities were obliterated in a matter of minutes with conventional explosives, and in seconds with nuclear weapons. Nuclear weapons demonstrated the fundamental truth of Albert Einstein’s famous equation39 E = Mc2—a small amount of mass can be converted into a gargantuan amount of energy in an instant! Modern war left much of Europe and a significant part of Asia in ruins. The spectre of nuclear annihilation hangs over us still.

16  Navigating on the Titanic

The key nation states in this fatal competition were Germany, Japan, Italy, Great Britain, Russia, and the United States. By far the most important was the United States. As we have already outlined, it had a continent-wide market with more than adequate resources of all kinds, including croplands and all other energy sources. The United States was both an Atlantic and a Pacific military power, protected from direct European or Asian invasion by two vast oceans,40 the frozen Arctic to the north and relatively weak countries to the south. Germany, which had undergone its own political unification in 1871, was a clear and early rival for global economic and military pre-eminence. It was an industrial powerhouse, had ample coal resources, and might still have become the heart of the united states of continental Europe. Yet Germany’s economy would continue to be based primarily on domestic coal resources, notwithstanding the rising importance of oil for the transportation sector. Japan, forcibly awakened in 1853 to the realities of modern industrial power by the steam-powered gunboats of Commodore Perry of the United States, began its own industrialization process in earnest. Japan had aspirations to be an island empire in Asia Pacific, not dissimilar to Britain. But Japan possessed no major indigenous sources of energy. Eventually, lack of energy security in respect of oil would prove to be both Germany’s and Japan’s strategic undoing. Great Britain had developed oil reserves in Persia (Iran), and it possessed a formidable navy to protect the sea lanes. Russia had plenty of energy of all kinds including oil, cropland, and other resources in an enormous expanse of territory, along with a sizable population. But Russia suffered from domestic political turmoil and lay open to invasion by land from the west. And notwithstanding the subsequent development of a comparatively brief Soviet Empire to rival the global hegemony of the United States, Russian institutions have not yet parlayed an enormous resource wealth into a preeminent and prolonged global presence. In many ways, the unsatisfactory conclusion of World War I, along with the huge reparation payments levied on Germany, begat World War II. Oil played a pivotal role in both wars. And indeed, as we shall outline, oil, and increasingly natural gas, continues to figure prominently in war and political upheaval in the Persian Gulf and Caspian Sea area to this day. In fact, the United States organizes its global military command structure with a central focus on this geographic area.41 Even coal, by current estimates the most plentiful fossil fuel, may soon figure prominently in the energy security of the Asia-Pacific region.

Economic Instability and Depression The global economy was in most respects the initial creation of the nineteenth century, not the twentieth. Free trade policies, with Britain in the lead, were supplemented by the widespread adoption of the gold standard, effectively

Chapter 1. The Brief History of Economic Growth  17

producing a common global currency. In such a world, international trade flourished. But the combined calamities of World War I from 1914–18 and then the Great Depression of the 1930s put an end to the gold standard, as well as free trade. Depression encouraged punitive protective tariffs and competitive currency devaluations that left the globalized market system in disarray. The total war of World War II would then rip to shreds any semblance of peaceful global commerce. In a mere 31 years—from 1914 to 1945—the world had experienced two World Wars and a Great Depression! Whatever else its merits, the market capitalism of the time was obviously no advertisement for global stability. The Great Depression began in 1929, but in fact the entire period from 1800 had been marred by repeated booms and busts of the economy. In the Great Depression, however, unemployment exploded in some nations to 25 percent or more of the labour force. It was also prolonged, persisting until 1939 in many countries. As a result, domestic political turmoil within industrial countries was widespread and featured a profound debate about market capitalism and its internal dynamics. Income inequality was also very great and rising in the 1920s, but it was the high and prolonged unemployment of the Depression that was so especially politically destabilizing. In fact income inequality lessens in depression, at least for those with an income. The wealthy suffer the largest loss of wealth and income in depression, even if they are not left destitute as a result. Accordingly, the intellectual debate centred on the role of government in relation to the fundamental instability of capitalism exhibited by the repeated booms and busts of economic activity.

Market Capitalism Reinvented It took government spending on a massive scale, first in the preparation for war and then in World War II, to end definitively the Great Depression. With American leadership, the global economy would be restored after World War II, but with the U.S. dollar as the world’s reserve currency. The subsequent Pax Americana kicked off a spectacular spurt of economic growth in the war-ravaged economies of continental Europe and Japan, and to a more modest but nonetheless robust degree in the United States, Canada, Australia, and New Zealand. During this period of strong productivity growth from 1945 to 1973, the various versions of the “welfare state” were invented, or further developed, in each Western country.42 Government’s share of the peacetime economy expanded, although to different levels in different countries. Nonetheless, the underlying program for social and political stability in the post-WWII industrial economies was economic growth. Economic growth even cured government debt problems accumulated in depression and war, and it did so without having to raise taxes or cut program spending. Income inequality lessened sharply as well. In a 1963 speech President Kennedy, when referring

18  Navigating on the Titanic

to economic growth in one state helping all other states, observed that “a rising tide lifts all the boats.”43 Economic growth also provided a dividend to expand both the military-industrial complex and social security. Or so it seemed. A larger government sector, it was believed, would at the very least help to stabilize the economy as long as the government was willing to finance its spending by borrowing or printing money in recessionary times. And following the policy prescriptions of the famous analyst of the Great Depression, John Maynard Keynes, governments would proactively and aggressively run deficits—in principle of any size if need be—in order to “kick-start” an economy finding itself in depression.44 Keynes, an English aristocrat, took a paradox that is at the core of market capitalism and turned it into a general theory of economic recession. The paradox is that while more saving by society provides the wherewithal of more and better tools, the new tools may not be forthcoming unless capitalists have confidence that they will be able to sell the output at a profit. In short, the prodigious mass production of capitalist society has to be met with an equally prodigious mass consumption. Keynes theorized that the equilibration process of saving and new capital investment was not, as some believed, automatic. “Business confidence” is ephemeral and subject to non-rational “animal spirits,”45 capable of alternating between extreme optimism and pessimism and with viral qualities in spreading these contagious attitudes and their consequences throughout the community.46 In economic slumps, income and employment can cascade downward, with multiplied effects. Paradoxically, therefore, more saving could lead to generalized recessions, even deep and prolonged slumps such as the Great Depression. Governments, presumably free from the same animal spirits, could counteract this process by spending more than they raised in taxes, boosting aggregate demand, and otherwise acting to stabilize the situation.47 While Keynesian ideas would continue to be debated and refined among university economists, a Time Magazine headline in 1965 famously pronounced, “We Are All Keynesians Now.”48 Keynesian economics had won the affections of government policy-makers in the United States and elsewhere. Thereafter, any recession would be met with countercyclical government-directed fiscal and monetary measures. The last ditch policy cure for depression had morphed into a prescription to “fine tune” the business cycles of capitalism.

More Institutional Paradoxes Geography is not destiny. The availability of temperate climates, ocean and river transport, and bountiful primary energy sources, important as they are, is not enough to explain the relative success or failure of human societies.

Chapter 1. The Brief History of Economic Growth  19

Economists have long been interested in the role of economic, social, and political institutions in facilitating the processes of economic growth.49 At least since Adam Smith, they have been focused on the central role of markets, as outlined above. Markets facilitate specialization, learning by doing, and the spread of knowledge. They encompass all the information available to the community. They are profoundly individualistic and driven primarily by self-interest. Yet they are self-organizing and coordinating to the benefit of all. Markets result, as Adam Smith famously noted, in a collective benefit “as if by an invisible hand.” Markets simultaneously determine the price of all traded goods and services and the income of each person in the community. And there is a deep morality at the core of the idealized market.50 It is based on individual freedom, the possession of one’s self, the right to choose, the right to the rewards from one’s actions as well as individual responsibility for those actions.51 Yet we have already noted one paradox: competitive markets will not generate technological change without government-granted temporary monopolies in the form of patents.

Limited Liability and the Leverage of Debt And there is another paradox. Perhaps the most important decision-making organization of modern capitalism has been partially freed from one of the fundamental principles of idealized markets. The modern corporation, now global in scope and scale, has been granted limited liability. This severs some of the tight link between the costs and benefits of an action in risky situations. Corporate owners are not fully responsible for the effects of their actions. Corporate debt, using other people’s money, then leverages the potential reward to the decision maker and does not have to be all repaid in the event of bankruptcy. In short, limited liability introduces an element of “moral hazard,” and debt leverages it. Together these factors encourage risk-taking and allow a greater marshaling of capital in a single enterprise. Adam Smith said of the early versions of corporate entities, This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery. Such companies, therefore, commonly draw to themselves much greater stocks than any private copartnery can boast of.52

While Adam Smith was not ultimately a fan,53 the corporation, with limited liability and potentially perpetual life, has emerged as the dominant economic organization in Western capitalist society. And it has come to enjoy all the rights of a real person—even, in the United States, the right to free speech in the political marketplace.54 But the corporation is a purely legal

20  Navigating on the Titanic

construct. It is not a real person. And this, too, is very important. When the corporation grows beyond the ownership of its entrepreneurial founder and is widely held by a large number of shareholders, it undergoes a crucial transformation. The corporation’s controllers or managers, where control is now separate from ownership, are still agents of the owners. As such, they are legally bound to pursue the interest of the owners. But now the owners are a disparate collection of individuals, with many different perspectives on what is in their interest. Accordingly, the only common denominator of their collective interest is “profitability,” the proverbial “bottom line.”55 The reason why this is so transformational is that it potentially makes the corporation an economic decision maker with far more rationality in pursuing the economic interest of its shareholders than most of the shareholders themselves would exhibit. Individual shareholders may have multiple priorities, even conflicting priorities. They may be consumed by emotions that override reason or logic.56 The corporation, however, with its narrowly defined mandate and, at least in its global manifestation, its legions of technically trained bureaucrats, may escape or at least minimize these cognitive and emotional limitations.57 The corporation might be likened unto a giant computer. It is designed by humans and programmed by humans, even operated by humans. But it is not a human decision maker. This is its strength, and perhaps its weakness.

The Driving Motive of Capitalism Perhaps it should not really be considered a paradox that the mass production of capitalism has to be met with an equally mass consumption, by someone. After all, we live in a materialist, consumer society. In the modern U.S. economy, for example, consumer spending is roughly 70 percent of GDP, while new residential construction represents from 4 to 6 percent. But if the motive force of capitalism is simply consumption, what drives some humans to earn ever more real income when, beyond building a few palatial homes, the income cannot possibly be consumed and therefore must be devoted to building more and better tools? We could assert that humans have a natural instinct to “truck, barter and trade” and a natural desire to improve their tools. But that still leaves us with the question of why these traits suddenly found greater expression in some societies than in others. Why does this behaviour persist, even to this day? And someone has to finance the desire to make better tools or more tools. Not every inventor is an entrepreneur or financier or even necessarily a saver. Why would individuals save and invest on the scale evidenced by modern capitalist societies? To explain capitalist economic growth, the static market model has to be further animated by a desire to accumulate productive wealth or capital.

Chapter 1. The Brief History of Economic Growth  21

Endless greed or gluttony is not enough. A more interesting and enduring explanation may be found in the fact that as social animals we care what our neighbours think of us.58 Presumably this human characteristic is part of our nature as social animals, but it found a unique expression in a “possessive” and materialistic society.59

Income Inequality and Relative Social Status In a materialistic society, we obviously care about our possessions. But we care not just about our absolute material comfort or consumption as most economic models would imply; we care also about our relative income and wealth. They define our status in the community. And status matters to our individual sense of well-being. Research shows that we give greater deference to those with a greater income. We perceive it as an indication of their innate abilities, whether or not this is merited.60 In this case, simple capital accumulation, and certainly the creation of a commercial or industrial empire, is a clear signal to others of our specialness.61 In short, markets not only determine our income, they also determine our social standing. Competition plays a role here to be sure. But it is a competition that is not limited to any one industry or market. As in the board game Monopoly, the players who end up with the most property and money win the most social esteem. They have the highest value. The difference is that this game of Social Esteem is perpetual, with a continuous influx of new players, although no one enters or plays the game equal to all the others. The desire for more income and wealth has no satiation point in this context. As long as no one gets and maintains a monopoly, it is a perpetual race in which someone is always shooting ahead, putting pressure on the rest to perform similarly. Its only limits would be those imposed by the nature of the universe itself. There is no reason to believe that the game will end just because everyone is satiated. Society is clearly more complex than the notion that it is made up of individuals, aware only of their individuality, intent on piling up endless amounts of wealth in an expression of their gluttony or greed. Power, envy, pride, and the desire for social esteem do exist. Humans are, after all, highly social animals. In one sense, we each individually are nothing, except what we are in the eyes of others. Unlimited accumulation of productive wealth, as well perhaps as its ostentatious display, is an important manifestation of the human desire for social status and power. Nor is the struggle for social status a totally vain or fruitless competition for the individual. Beyond some basic income level, everything in society is relative. The biological advantages in the search for mates that accrue to the possessor of relatively higher income or wealth—or those with the greatest prospects—are obvious. Income and wealth, of course, confer great advantages on one’s offspring. But they do so not only in the education, diet, and

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living conditions one’s children enjoy or in the inheritance of wealth, but also in the company in which children grow up, the values they inherit and their own sense of self-worth. On the other hand, being relatively “poor” can condemn one’s offspring to dangerous neighbourhoods, bad schools, bad dietary habits, low self-esteem and, perhaps worst of all, peers without knowledge or ambition. This is especially the case in a large city.62 Social status matters a great deal. It affects everything, including the stability of families and everyone’s health.63 Income and wealth inequality might therefore be an underlying motive for economic growth. Yet this is certainly not the assumption of the political arguments in favour of economic growth. In those arguments, the overriding proposition is that “a rising tide lifts all boats.” Moreover, the reason why this motive could produce a further paradox is that income and wealth inequality implies a build-up of debt, not only for capital expansion but also for consumption in order to justify that capital expansion. This is simply the Keynesian paradox of saving revisited.

An Unresolved Ideological Divide Market expansion and capital accumulation along with invention and its commercialization are the proximate driving forces of dynamic market capitalism. There is remarkably little debate about these matters. And very few seriously challenge the important role of governments in protecting private property, both physical and intellectual, as well as facilitating the expansion of competitive markets. There is, nonetheless, a deep philosophical divide in our society. It reflects the inevitable tension between the individual and the community. And it is a divide that cannot be fully resolved, except in unusual circumstances. Humans are a highly social animal but have an individual consciousness. Accordingly, when some people look at society, they see the individual. When others look at society, they see the community. Everyone sees only what they typically focus on. The nature of the individual’s relationship to the community and specifically to the state has preoccupied political philosophers for a long time.64 And, as outlined below, this unresolved question continues to plague our society to this day. This deep philosophical divide naturally finds expression in differing opinions and ideologies on the role of government in a market capitalist society, specifically on the role of government regulation, social insurance of various kinds, and income redistribution. The opposing ideologies reflect fundamentally different moral perspectives, different models of reality, as well as different interpretations of fact; quite naturally, they inform debate in the political marketplace. Those analysts who believe most strongly in individual freedom and responsibility are most inclined to emphasize the advantages of markets.

Chapter 1. The Brief History of Economic Growth  23

These individuals do not typically believe in the ability of governments, beyond some minimalist activities,65 to improve on the outcomes of private decision-making. From their perspective, when governments do intervene, it most often results in unintended consequences that make matters worse.66 In counterpoint are the perspectives of those who focus on political society, usually the nation state, and the sustainability of society in terms of its internal stability. These social analysts typically point out the imperfections of actual markets—the lack of competition, the asymmetries of information between buyer and seller, and the unaccounted for effects of private choices—when compared with the idealized model. They are less inclined to accept the market-determined distribution of income as always morally defensible and certainly not necessarily socially or politically stable. Accordingly, they may be more inclined to emphasize the role of randomness and pure chance in human life and therefore the need for governmentprovided social insurance. Following Keynes, they also point to the periodic generalized “panics” and recessions that appear to be endemic to market capitalism. And, following Keynes, they believe that governments, acting rationally, can correct for the many apparent failings of actual private markets. One of the most contentious debates between these opposing perspectives centres on the moral hazard that is implicit in all forms of social insurance, including government bailouts of failing private enterprise. Proponents of social insurance argue that such policies are necessary to contain the collateral damage to society from the variety of failings in private markets,67 including generalized panics, recessions, and depressions. But the proponents of social insurance are also compelled to seek greater regulation and control over individual and corporate behaviour in order to contain excessive private risk-taking. A fully insured society must also be a heavily regulated society if it is to minimize moral hazard. Those who are opposed to such policies see the danger in allowing either excessive risk-takers to accumulate or a rule-bound, government-dominated, sclerotic society to emerge. For them, downside market corrections, including recessions, are necessary to expunge or discipline the excessive risk-takers. They also would argue that individual freedom from excessive government regulation is central to innovation and economic growth. In the worst case, government rule-making is simply hijacked for the purposes of reducing legitimate competition. Monopoly business groups, unions, and professional associations proliferate; vested interests entrench themselves in the corridors of political and economic power.68 Society becomes more complex, more rule bound, more bureaucratic, and ultimately more political in both the public and private sectors. When this happens, it is more important to be in Washington or Ottawa than it is to be on the shop floor in Dayton or Oshawa. This sclerotic condition—a hardening of existing social relations—eventually incapacitates the state, overwhelms the efficiency and dynamism of the economy, and

24  Navigating on the Titanic

destroys basic political freedoms. Of course, in an ironic twist, the legions of lobbyists prowling the corridors of political power might also press for favourable deregulation if they were still assured that the downside risks would be socialized.

The Political Primacy of Economic Growth Despite this deep ideological divide, the single objective of economic growth remains a common element of agreement for the vast majority of voters, and it is the avowed promise of the opposing political ideologies. The current state of the economy is a dominant factor, if not the decisive factor, in North American electoral politics, and has been especially so since the mid-1970s.69 The vast majority of voters agree on the need for low unemployment, low inflation, and rising real incomes across the income spectrum. This is so much so that most politicians—on the left and right of the political spectrum—are loath to do anything that might be seen to undermine or slow the economy’s growth momentum. Nearly everyone looks to government as the single most powerful decision-making entity in society. But the fundamental philosophical divide in society remains. The most passionately committed disagree profoundly on what to do—wanting the government either to engage more fully or to withdraw more fully. They even disagree on what instruments of policy— expenditure, tax, or regulations—to employ. Those who favour greater regulation and social insurance are steadfastly opposed by those who favour deregulation, larger and more competitive markets, and greater individual responsibility. And there is really no alternative model of income and wealth distribution in our society, other than the fundamental outcomes of the market.70 Accordingly, high levels of employment are essential. Each side of the ideological divide has identified a profound feature of the human condition in a market capitalist society. Each side has developed an incomplete model of reality based on that feature. And each side knows that if it controls the government, it can potentially impose its vision of reality on everyone else. This is important, and we shall have reason to return to how our federal governments deal with this dilemma below. But first we must turn to the more recent experience of economic growth and the role of energy.

Chapter Two

Energy Matters: Energy Price Shocks and the Global Economic Transformation Notwithstanding the essential role of energy, its contribution to the growth of income per capita is often underappreciated. Economists for the most part have focused on the determinants of technological change and whether the latest round of invention based on the computer and the Internet is as powerfully productive as the earlier wave of invention based on such things as the internal combustion engine, telephones, television, central heating and air conditioning, jet aircraft, and electricity.1 The neglect of energy’s role largely reflects the remarkable abundance of fossil fuels, and hence their relatively low prices, through much of the past 150 years. This chapter, however, as the title implies,2 is meant to demonstrate how truly profound the impact of spiking energy prices have been on the economic performance of Western economies, with a special emphasis on the U.S. economy since 1973. It is not an exaggeration to say that spiking energy prices have changed everything. And it is important to understand exactly how it happened in order to appreciate how crucial our energy supply is to our collective future. Spiking energy prices not only led to poor short-term macroeconomic performance but also changed the focus of the domestic policy debate. Even more importantly, spiking energy prices motivated long-term structural changes in the North American and, indeed, the global economies. These structural changes, both domestically and globally, have given rise to income and wealth inequality and debt, which has vastly complicated our political economy and our ability to deal with future such crises.

26  Navigating on the Titanic

Energy and the Postwar Boom: A Rising Tide That Lifted All Boats The first 50 years of the twentieth century were replete with calamity on a global scale. They were hardly a testament to the advantages of market capitalism, especially and dramatically in Europe. Yet after two World Wars in quick succession, interrupted only by Depression, the leading industrial nation states reinvented themselves and the operations of the international economy. The United States led the way. The reinvention worked. From 1950 to 1973, per capita real GDP grew at an average compound rate of 8.06 percent annually in Japan, 5.02 percent in Germany, 4.95 percent in Italy, 4.04 percent in France, and a more sluggish but still respectable 2.42 percent in the United Kingdom.3 In the United States and Canada, whose economies were exempt from fighting on their own soil and the related war damage, per capita real GDP grew at an annual compound rate of 2.45 percent and 2.82 percent, respectively. In total, per capita real GDP of the global economy grew at a rate of 2.92 percent, compounded annually. The post–World War II economic boom was truly spectacular. Moreover, it corresponded with a period of low and enormously stable real energy prices. Figure 2.1 illustrates the case with respect to the real price of oil. In the United States, the leader of the growth club, the price of the energy content of both oil and coal actually fell in real terms between 1949 and 1972. The real price of natural gas increased, but the overall or composite real price of the energy content of fossil fuels was 27 percent lower in 1972 than it had been in 1949.4 It was in this period of low and even declining real energy prices that strong economic growth, including strong productivity growth, produced a rising tide lifting all boats. This era was—especially for male North Americans—the Camelot of economic growth. It was possible in this period to attain middle-class status, even on the basis of one income per family, without a high school education of the principal bread winner. A traditional family lifestyle predominated. Female participation in the labour force, although rising, was still well below that of males. The enormous contributions of women to the welfare of the family were not even counted in the official statistics of production. Still, GDP rose continuously. Life in North America, and increasingly in Western Europe, was very prosperous indeed.

Spiking Energy Prices and Productivity Collapse All this was about to change abruptly, and along with it the structure of the American economy and the family. The initial catalyst was the Arab embargo of oil exports to nations supporting Israel during the Yom Kippur War in late

Figure 2.1 Crude Oil Prices 1861–2011 (U.S. dollars per barrel, world events) Yom Kippur war Post-war reconstruction

Fears of shortage in US

Pennsylvanian oil boom

Russian oil exports began

Sumatra Discovery of production Spindletop, Texas began

Iranian revolution Netback pricing introduced

Loss of Iranian supplies

Growth of Venezuelan production East Texas field discovered

Asian financial crisis

Iraq invaded Kuwait

Suez crisis

Invasian of Iraq

“Arab Spring” 120 110 100 90 80 70 60 50

30 20 10 1861–69 

1870–79 

1880–89 

1890–99 

1900–09 

1910–19 

1920–29 

1930–39 

1940–49 

1950–59 

$ 2011 $ money of the day

Source: Reprinted from BP Statistical Review of World Energy June 2012, p. 15.

1960–69 

1970–79 

1980–89 

1990–99 

2000–09 

2010–19 0

1861–1944 US average. 1945–1983 Arabian Light posted at Ras Tanura. 1984–2011 Brent dated.

Chapter 2. Energy Matters  27

40

28  Navigating on the Titanic

1973. Accordingly, oil prices get most of the attention in the history of the period. Oil represented by far the largest share of primary energy consumption, and oil prices increased the most. The real price of oil (that is, adjusting for inflation) spiked to over $50 per barrel. But the increases in energy prices were not limited to oil. From 1972 to 1979, the real price of the thermal content of coal in the United States increased by 95 percent. Natural gas prices, reflecting a sudden shortage, rose 280 percent in real terms. In total, the weighted average real price of the energy content of all fossil fuels rose sharply over that period (from $1.32 to $3.24 per million Btu).5 Notwithstanding that this was a period of generalized price inflation, energy prices rose far faster. But worse was yet to come. Oil prices spiked again with the Iranian Revolution in 1979. Then in 1980, Iraq attacked Iran. The world lost oil production from both countries. The Soviet Union moved to occupy Afghanistan in 1980, further aggravating concerns about the security of global oil supplies. The real price of oil spiked to over $100 per barrel. Other energy prices went up, too.6 The economic impact on large energy importers was dramatic. For the entire period from 1973 to 1990, Japan’s per capita real GDP growth dropped to a 2.96 percent average annual compound rate, Germany’s to 1.7 percent, Italy’s to 2.55 percent, and France’s to 1.91 percent. Even in the United States and Canada, although large energy producers, the average annual growth rate of per capita real GDP fell to 1.96 percent and 1.84 percent, respectively. Globally, the average annual real GDP growth per capita dropped to 1.38 percent.7 This was less than half the earlier postwar rate. Clearly something profound had taken place.

Stagflation and the Policy Response Initially, the impact of the international oil price increase on North American consumers was muted by a political decision to “blend” the price, allowing the international price for imports and “new” domestic production, but not for existing or “old” domestic production. The new “blended price” of domestic and imported oil was higher, but it was not as punishingly high as the international price. However, these domestic pricing restraints were subsequently removed in 1980. This was done ostensibly to increase domestic supply and promote conservation. But now consumers were left to feel the full impact of the international price increase. In 1980–81 the North American economies suffered their deepest recession since the end of the Second World War. It was the direct result of two factors: the impact of energy price spikes on short-run output and employment performance, and a monetary policy decision to deal with a coincident problem—cost-push inflation.

Chapter 2. Energy Matters  29

Recession Increases in the price of energy, oil in particular, can cause recessions because of the very large proportion of national income that is devoted to energy consumption. For example, in 1981, U.S. expenditures on all primary energy represented 13.7 percent of GDP.8 For petroleum alone it was 8.5 percent. Moreover, households and businesses do not immediately reduce their consumption of energy enough to offset the impact of higher prices on their budgets. Instead, households cut expenditure on other items, while many businesses initially attempt to pass some of the cost onto consumers. For households, it is not simply a matter of stubbornly sticking with old behaviour patterns.9 In part they cannot immediately adjust because their prior capital decisions lock them in. A large house in the suburbs and a car or two for commuting to work are not quickly exchanged for a small downtown condo and the subway.10 Even if a decision is made to move closer to work, the expansive suburban home and the gas-guzzling automobiles have to be sold at a capital loss. They are suddenly worth less to everyone. That capital loss, whether realized or not, is a material impact to the average household; most of their net worth is in the value of their homes and automobiles. And these assets do not go out of service. If sold, they continue to be used by someone else. So oil consumption or energy consumption in general does not immediately adjust. To pay the higher energy costs, households must reduce their consumption of other goods and services, or their saving rate, if they do any saving. When multiplied across many households, overall consumption spending declines. If businesses cannot pass on the higher energy costs, then they cut other costs or cut production, usually through layoffs. The increase in the price of energy, or in this specific instance oil, acts as a vast tax on households. Of course, the resulting added revenues mostly go to the oil sector. But the oil industry will not typically spend its money in the same manner as would the consumers of oil, if producers spend it at all. Indeed, the producers are likely not located in the same part of the country, or even in the same country when oil imports are involved. Accordingly, the larger the share of imports in the oil market the larger the negative shock to overall domestic consumption. Nor does the supply of oil respond immediately to rising prices. That takes time as well. Huge shifts in financial flows are involved. To illustrate, take a more recent example. In 2007 the U.S. economy consumed roughly 20 million barrels of oil per day. At a price of $50 per barrel, that is $1 billion dollars per day flowing from oil consumers to oil producers at home and abroad. If the price spikes to $100 per barrel, that takes an additional $1 billion per day out of consumers’ pockets. That money has to come from somewhere. Of course it also goes somewhere. But if half of that oil is imported, then only half of the money flows into domestic oil companies. The rest—$1 billion per day— goes abroad. These shifts in spending power all have multiplier effects on the economy.

30  Navigating on the Titanic

Eventually, of course, the purchasing power gained by the oil sector does get fully recycled into the economy and causes resources, including labour resources, to be redeployed to the energy sector and regions of the country. Factory workers in Michigan, Pennsylvania, Ohio, and Ontario, along with their families find their way to Texas, Oklahoma, Louisiana, and the Gulf Coast or to Alberta. But this process takes time. Human capital, which defines our degree of specialization in terms of formal education or on-the-job training, tends to lock an individual into a specific occupation, a specific employer, a specific industry, or even a specific geographic location. Indeed, a skilled worker could find that all of the above applied depending on local skill-accreditation rules. A modern two-income family is even less mobile geographically. And because energy is a capital-intensive industry, its expansion does not directly create as many jobs as may be lost in the non-energy businesses. Dramatic change is simply not easy or rapid. Resources cannot immediately shift from one industry and region to another. In non-oil-related businesses, factories reduce the number of shifts, unemployment rises, machines are idled, and productivity collapses. Unemployment remains, at least temporarily, higher. There is an enormous amount of personal and family stress and pain, and the potential for much political discontent. That a transformation takes place at all is the magic of the market. Eventually, new machines are bought, and workers change jobs and locations. Capital losses to households and businesses are absorbed. Large unspent oil revenues, accumulating in reserve funds around the globe, are channeled to profitable projects.11 In the long run, everyone and everything adjusts. In fact, wait long enough and the old generation of workers who may not have wanted to move or did not have the ability to acquire new skills are all gone. The ultimate political question, of course, is how long we can wait to find our place. The political tolerance for short-run pain may be far less than required by the natural adjustment processes of the market. It is a matter to which we return in later chapters.

Inflation The outline above explains the recession potential of energy price spikes, but why the inflation component of the term “stagflation”? In the 1970s in the United States and Canada, cost-of-living clauses were widespread in labour contracts; if wages were not automatically indexed to inflation, workers typically would demand compensating wage increases at their next round of negotiations. Wage bargains even began to anticipate future inflation. This was before the rise of Asia, so most North American workers had real bargaining power. And it was not just labour that responded in this manner. Lenders similarly built expected inflation into the interest rates charged to borrowers. Businesses in turn tried to pass on these costs in higher prices.

Chapter 2. Energy Matters  31

In short, no one, not business or organized labour or financiers, wanted to absorb the higher cost of energy as a reduction in their own real income. It was like a hot potato. The net result was an inflation of all prices and nominal interest rates. Moreover, inflation feeds on itself. Along with unemployment, then, higher oil prices also brought “cost-push” inflation. Hence the new term, stagflation, was born. Inflation, however, simply obfuscates for a time where the final burden of the higher real cost of oil will fall. And inflation imposes its own additional deadweight loss of productivity on the economy, as well as redistributing income from persons whose incomes are contractually fixed. In this context and in the midst of recession, with no productivity growth, everyone was a potential loser. The inflation process is not possible, however, if monetary policy does not accommodate it by expanding the money supply in line with the ever higher nominal wage and price level. On the other hand, when the monetary authorities restrain the growth of the money supply, and refuse to facilitate the cost-push inflation process, the short-run cost in unemployment and reduced output can be very sharp. Money is now scarce and interest rates soar. Loans are called in. Employers freeze wages or lay off workers. The economy begins to contract. The contraction is made worse depending on the degree to which inflation expectations are embedded in the economy. After the first oil price spike in 1973, monetary policy had been accommodating out of concern for rising unemployment. But when international oil prices spiked again in 1979–80, the monetary policy of the United States changed dramatically. Under Paul Volker, who had been appointed by President Carter as chairman of the Federal Reserve Bank of the United States, monetary policy became distinctly not accommodating to the wage and price inflation process. It was no longer possible for business to pass on wage or price increases that compensated for oil price increases. Unemployment soared. The United States suffered its deepest recession since the 1930s. But the new monetary policy did wring out the cost-push inflation.

Changing Focus of Economic Policy The initial sharp decline in productivity also changed the domestic policy debate beyond the adoption of a more stringent monetary policy. The focus of public policy shifted to the need to deregulate markets, expand international trade, and reduce taxes on investment income and on research and development. In short, the focus shifted away from maintaining domestic demand toward expanding aggregate domestic supply, particularly through productivity gains. The political triumph of “supply-side” economics came with the elections of President Ronald Reagan in the United States and Prime Minister Margaret Thatcher in the United Kingdom.

32  Navigating on the Titanic

A decade of higher oil prices brought new oil supply on stream in the early 1980s. Meanwhile, oil demand plummeted in response to global recession, conservation initiatives, and fuel switching. As a result, real oil prices retreated and eventually collapsed in 1986 as illustrated in Figure 2.1. Fossil energy prices generally in North America dropped almost to their typical post-WWII levels.12 Subsequently, overall economic growth resumed, only this time without inflation. In addition to the anti-inflation policies of Chairman Volker, a low-inflation environment was being given a huge long-term assist by the underlying shift in economic activity to the rising industrial nations of Asia Pacific. Economic policy was changing in the Asia Pacific as well.

History Repeats Itself: Asia Pacific Replaces the Great Lakes States The expansion of the global economy to include the very populous, lowwage nations of Asia Pacific put competitive pressure on the wages of North American workers. These nations represented, after all, a huge increase in the global supply of labour. But that was not the only competitive impact. There was also a huge energy cost advantage in Asia Pacific. The Asia-Pacific region, China in particular, has now displaced the states bordering the Great Lakes as the leading global manufacturing centre of the world for the same reason that the Great Lakes states once replaced England—the underlying cost advantages of the energy regime. The owners of machines—which require fuel to power them and indirect energy in the form of labour to operate, monitor, and maintain them—will naturally attempt to find the lowest-cost energy jurisdiction in which to operate, other things being equal. Lowest cost means simply the lowest combined human and direct energy costs. So when China took over from North America’s Great Lakes area as the manufacturing workshop of the world, it did so in part because China has far lower direct and indirect energy costs.13 China gets 70 percent of its primary energy from coal. Coal is the cheapest energy source and the one most central to the production of cement, steel, and glass—the materials of modern cities. Asia Pacific, as a region, gets over 50 percent of its primary energy from coal. By contrast, coal represents 22.1 percent of primary energy use in the United States and only 16.9 percent for the European Union. The European Union’s energy mix is particularly high cost. This is illustrated in Table 2.1. The indirect energy costs embedded in wages are also far lower in China than in North America. The low wages in China simply reflect the lower energy cost of a typical Chinese worker’s standard of living (including a diet with far less meat and dairy, less living space, less heating and air conditioning, and no personal automobile or even motorized transport).

Chapter 2. Energy Matters  33

North Americans, by contrast, have a standard of living that entails enormous energy consumption. Family-sized personal automobiles, suburban and spacious accommodation, air conditioning, high protein meat diets, and vacations far away from home are the standard American dream. The resource-intensive industries in North America—agriculture and other resource extraction and processing industries—also require a high energy input. So North Americans use far more energy per person;14 moreover, they use energy that is more expensive per unit, particularly oil and natural gas.15 Table 2.1 Composition of Primary Energy Consumption, 2011 (percentage of total primary energy consumption) Primary Energy Source

United States

European Union

China

India

Asia Pacific

Oil

36.7

38.2

17.7

29.0

27.4

Natural Gas

27.6

23.8

4.5

9.8

7.3

Coal

53.2

22.1

16.9

70.4

52.9

Nuclear

8.3

12.1

0.8

1.3

2.3

Renewable

5.3

8.9

6.7

7.0

6.1

Source: Calculated from data in BP Statistical Review of World Energy June 2012, p. 41.

As energy prices spiked in the 1970s and early 1980s, capital moved away from the industrial heartland of the Great Lakes states. Some corporations literally packed their machines in crates and sent them off to lower-cost jurisdictions. Others outsourced their production by contracting out to lowcost suppliers around the globe. Still others built plants elsewhere, moving initially into southern Ontario, southeastern United States, and Mexico.16 But most corporations eventually went to Asia Pacific, especially those Asian countries with the cheapest overall energy costs. China, with most of its primary energy coming from coal—and the modest diet, dwellings, and transport needs of its industrious and reliable workforce—became the obvious choice. None of this happened instantaneously. The industrial shift to the AsiaPacific region at first went to postwar Japan and then in the 1980s to the smaller Asian Tigers—Hong Kong, Taiwan, Singapore, and South Korea. Nor could it have happened without profound changes in Asian ideas. The most profound was the end of Maoist Communism in China, beginning in 1979 under Premier Deng Xiaoping. A new but relatively peaceful political revolution gradually ushered in market-based economic policies. Institutional reform and economic momentum increased in the 1990s. Then

34  Navigating on the Titanic

China joined the World Trade Organization in 2001 and became an official part of the global economy, and a leading member of the global growth club with the second-largest national economy in the world.

Machines Replace Humans Manufacturing activity does not have to move to low-cost energy jurisdictions if it can eliminate a substantial part of its indirect energy requirements in the form of low-skilled labour. This is the case even if the new technology uses more direct inanimate energy, provided only that the overall net energy cost is lower (including the wage bill for higher-skilled labour if necessary). Machine intelligence is the key. As machine tools become more intelligent, they can often replace humans in increasing numbers of applications. Repetitive, dangerous, low-skill functions are most at risk. The revolution in information and communications technologies has provided that opportunity to replace low-skilled labour with “labour-saving” machine innovation. Robots can replace humans in the production process. The revolution in communications and information technology was initially slow to penetrate the market and then slow to produce a positive effect on productivity. In total, however, technological change picked up momentum in the 1980s, continued in the 1990s and then exploded at the turn of the century. While U.S. business productivity initially declined with the energy price increases of the 1970s and early 1980s, it subsequently grew strongly again, almost matching its postwar growth rate.17 The primary reason for this growth has been the widespread displacement of low-skilled labour through both import substitution and technological change. Profits have risen sharply, and low-skilled manufacturing employment has fallen precipitously.

The New Gilded Age The impact on the United States of the triple threat of low-wage and low-­ energy-cost Asian competition along with labour-saving technological change has been profound. Low-skilled workers in the West, especially manufacturing employees, have suffered the most in the past 30 years. These global market forces did, however, lead to more high-skilled employment. Jobs were created in high technology, marketing, supply management, administration, law, finance, insurance, and real estate. And there was a rising wage premium for highly skilled workers.18 Nonetheless, many, many more jobs were created in relatively low-wage retailing, food service, tourism, warehousing, security, property management, and personal services.19 Coincidentally, profits as a share of national income rose and stock markets boomed. The Congressional Budget Office (CBO) has documented the increase in household real income inequality between 1979 and 2007.20 Changes in the

Chapter 2. Energy Matters  35

distribution of income were generated by the operations of the market, not governments. On the face of it, the growth in average real market income is respectable; it grew by 58 percent between 1979 and 2007. But this average covers up a far more sobering story. The CBO goes on to note that median market income grew by only 19 percent. In short, half the households in the United States had real market income growth over the 27 years of less than 19 percent! By contrast, the average real market income of the top 1 percent of earners nearly tripled: their share of total market income went from about 10 percent to 21 percent! The top 20 percent of households took in 60 percent of the real market income in 2007, up from about 50 percent in 1979. No one planned or even foresaw this outcome. It simply represents the compelling but potentially socially and politically disruptive logic of capitalist growth. A similar increase in income inequality has been documented in a large majority (two-thirds) of developed countries over roughly the same period.21

Western Consumerism Undaunted and the Build-Up of Debt The growth of income inequality, where the incomes of the rich are growing more rapidly, leads to higher savings. The rich save more.22 The growth in Asian income has also resulted in higher global savings. Asians typically save more than North Americans (and their income inequality is also greater). Higher oil prices also lead to higher savings by oil-rich jurisdictions. The extra global savings has to find an investment outlet. In the past 20 years, those savings financed a huge expansion of residential and commercial real estate investment and related consumer durable spending as well as other consumption, principally but not exclusively in the United States. The net result was that the United States began running significant current account deficits, largely because of direct imports of energy as well as indirect energy imports in the form of inexpensive Asian manufactures, principally from China. This deficit was financed by a net capital inflow from foreigners. Naturally, the financial services industry in the United States vastly expanded its share of the economy, jobs, and corporate profits, as it channeled the savings to ultimate borrowers. At the same time, it created new financial products as well as a host of new financial institutions, many of which were unregulated.23 Low-income households were among the big beneficiaries, at least initially. Notwithstanding the tiny increase, if any, of real income of the vast majority of American households, consumer spending continued to rise rapidly as a share of total spending. Consumption and residential construction spending in the United States went from 63 and 4.4 percent of GDP respectively in 1980 to 69.7 and 6.0 percent in 2005. This increase was facilitated by a vast expansion of household consumer and mortgage debt—much of it sub-prime debt.24 The ratio of total household debt to personal disposable income rose dramatically, and the saving rate fell sharply.25

36  Navigating on the Titanic

Widespread home ownership is thought to make a society more stable and productive. Accordingly, public policy in the United States strongly promotes home ownership through a variety of measures.26 The baby-boom generation wanted to own their homes. Not only the absolute number but also the share of households owning their own homes increased in the period.27 Increased housing demand raised existing home prices and encouraged the construction of ever more and ever larger suburban homes. More suburban shopping malls popped up everywhere. After 1986, low oil prices facilitated commuting by automobile. Low electricity and natural gas prices facilitated purchasing of more spacious and comfortable living quarters. Rising home prices also became the incentive for people to buy a new home as soon as possible and for lenders to make the mortgage monies available on attractive, easy entry terms. Mortgage debt rose. Higher home prices, however, meant greater home equity for existing owners. This equity also became the basis for a consumption spending increase, despite constrained real income growth for the vast majority of households. Home equity could be converted into tax-deductible mortgage debt, with the funds used for new kitchens or appliances or cars or boats and vacations. A virtuous cycle ensued of more debt, higher home values, and more personal consumption. In total, of course, household debt, both consumer and mortgage debt, rose sharply. But inflation remained relatively low and therefore so did interest rates. The debt was still sustainable—as long as nothing went horribly wrong. But the build-up of debt is like the build-up of methane gas in a mine. All it needs is a spark to set off a catastrophic event. Spiking energy prices are sufficient to accomplish the task.

The Trapped Households of North America Low-income households ultimately benefited the least from the economic expansion following the collapse of energy prices in 1986. They benefited the least because economic forces, both global and domestic, were at work to trap them in relatively low-income occupations. Two-income households were an increasingly common if not necessary lifestyle. As a consequence, more and more children had to depend mainly on the education system for their adult-directed learning. These low-income households were also the most vulnerable to the energy price increases that lay ahead. As illustrated in Figure 2.1, oil prices had retreated substantially by 1999. But it was not just oil prices; the composite fossil fuel real price index was only about 5 percent higher than it had been in 1949. In the early 2000s, however, worries over resource depletion and terrorism, culminating in the attack of 11 September 2001 and the subsequent wars in Afghanistan and Iraq, all contributed to the oil price increase. Most important, however, was the spectacular expansion of the Asian economies, particularly China and India. Consequently, oil prices rose sharply after 2004. This was not a supply

Chapter 2. Energy Matters  37

shock, but a demand shock. China, which had been a net oil exporter, now became a large net importer, second only to the United States. Natural gas prices were also now spiking higher over concerns about depletion of conventional natural gas in North America, along with the increased use of natural gas in electricity production. Even coal increased in price, although far more modestly. The structural changes imposed by the oil price spikes of the 1970s and 1979–80 on the North American economy were profound. When oil and natural gas prices spiked once again in the early 2000s, they did not cause a marked increase in the overall measure of inflation. The primary reason was that by that time most of the North American labour force had long since lost its ability to resist a reduction in real wages. Asian competition and domestic technological change had changed everything. But the new compounding factor was debt. The overhang of excessive household debt and constrained real income growth, combined with rising oil and natural gas prices, pricked the real estate bubble and precipitated the financial crisis of 2007–2009. Home prices fell. Consumers were faced with the double blow of contractual debt obligations, in many cases being reset at higher interest rates, and sharply higher energy costs. Inevitably, consumers chose to reduce other purchases. Even worse, increasing numbers of households were forced simply to walk away from their homes and mortgages. Then the virtuous cycle-up inverted into a vicious and multiplied cycle-down. Financial institutions staggered under the weight of non-performing loans. Trust in the integrity of the financial sector imploded. The economy collapsed into deep recession, abetted by the excessive risk-taking and the resulting near meltdown of the financial sector. The real estate bubble was the result of a combination of long-standing government policies to promote home ownership, lax or non-existent financial regulation, and perverse incentive structures throughout the financial system. All conspired to encourage excessive credit creation and asset speculation. These factors were further facilitated by monetary and fiscal authorities reluctant to let the economy slow down or unemployment to increase. The epicentre of the global financial earthquake was in the United States, but it was quickly transmitted to European financial institutions. In any case, Europe had its own real estate bubble. Virtually the entire Western world was, to a greater or lesser degree, implicated. The end result was a very near total collapse of overlevered international financial institutions throughout the Western economies. In response, the government sector in these economies went deeply into deficit, according to established Keynesian prescriptions. Moreover, governments bailed out the private banking system and other financial institutions, acquired several others, and also bailed out two automobile manufacturers in the United States and Canada. Monetary authorities similarly supported

38  Navigating on the Titanic

financial markets with a vast increase in liquidity, by purchasing suspect debt and by cutting the interest rates charged to banks to near zero. Most Western economies stabilized, but a robust economic recovery has not yet materialized. Economic growth remains tepid, and unemployment and underemployment are still high. But after an initial sharp contraction, oil prices have also remained relatively high and even recovered somewhat as the economy began an overall recovery in 2009–2011. There are now a huge number of vulnerable households, even those with jobs. The New York Times reported in July 2012 that “half of the jobs in the nation pay less than $34,000 a year…. A quarter pay below the poverty line for a family of four, less than $23,000 annually.”28 A new measure of poverty produced by the U.S. Census Bureau indicated that about 100 million people in the United States were “poor” and “near poor” (this is with incomes of 50 percent or less above the poverty line).29 These people, more than most, live paycheque to paycheque. They have little, if any, savings. They are also the target market for sub-prime lenders and those who charge double-digit interest rates for small and short-term loans. They are burdened by debt.

European Economic Stagnation After the Second World War, a major goal in Europe was to create a single market as big as or even bigger than that of the United States, only this time without war. With a market of this size, Western Europe could potentially equal the United States in economic, political, and even military power, although the European Union shows no inclinations toward the latter objective. As a single economic entity the European Union exceeds the United States’ economy in size, although no single member state, even Germany, comes close to being comparable.30 Europe suffered the same productivity collapse after the oil price spikes of the 1970s as other Western economies. One policy response was to move toward greater economic and political integration, establishing the European Union in 1993 in order to improve productivity. Some states subsequently went even further with a monetary union in 1999 and the creation of the Euro zone and the European Central Bank, although the institutional change stopped short of full integration of their fiscal policies. This has recently proved an important design flaw.31 The European Union uses far less energy per capita than the United States and Canada, but that is largely due to its relative lack of fossil energy wealth. Accordingly, it must rely heavily on imports of oil, natural gas, coal, and uranium. And indeed, energy security continues to be an Achilles heel of the European Union. Unlike North America, Western Europe depends profoundly on access to energy and other resources from Russia, Africa, and the Middle East. Accordingly, the European Union is very vulnerable to spiking energy prices, especially now when a large part of the southernmost part is mired in a Gordian knot of economic problems.

Chapter 2. Energy Matters  39

Europe’s economies, particularly in the south, have been heavily damaged by the global fallout from the recent sub-prime mortgage crisis. Moreover, government debt, the burdens of a highly developed welfare state, the stranglehold of tight regulation, an aging and stagnant population, and the absence of economic growth have put those new Western European political relationships in danger. Unemployment in some southern European states is approaching depression levels. To make matters worse, even northern Europe hovers close to the edge of a general recession. Almost everywhere in Europe, public trust in government has declined.

Conclusions In 1973, oil prices spiked dramatically. They did so again in 1979–80. Productivity growth in the industrial countries fell off a cliff. Western economies experienced high inflation and high unemployment—previously considered to be an improbable, if not impossible, combination. A new term, “stagflation,” was invented. Inflation would be expunged in the 1980s. Oil prices and energy prices generally would collapse by 1986. Productivity growth was restored, particularly in the private sector in the United States, and thanks in large measure to the advent of innovation in information and communications technology. But the manufacturing jobs lost in recession would not come back. The manufacturing heartland, not only of America but of the world, centred in the Great Lakes states, would not recover its former global preeminence. Something very profound had happened. Industrial employment had moved to a cheap energy regime in Asia, especially China. This competitive force was countered in the West by labour-displacing technological change, magnifying the negative impact on employment opportunities in high-productivity, high-wage industries. Indeed, households in the United States and throughout the industrial West have been squeezed by no less than five coincident factors: • increased competition from an enormous influx of low-wage Asian labour into the global economy; • competition from a cheap Asian energy regime based primarily on coal; • labour-displacing technological change in the West; • an Asian economy with an export focus and very high savings rates; and • an economic policy debate and practice, especially in North America, that focused on productivity growth and investment income and did not place the interests of domestic labour at its core. As a result, the income growth of low-skilled workers in North America was marginal at best. For most, real incomes went in reverse. Increasing numbers of households needed two incomes. Income inequality began to rise

40  Navigating on the Titanic

again, quite sharply. But household consumption, including new residential construction, rose. Household debt levels ballooned. When energy prices spiked again after 2000, the entire financial structure was shaken to the core. The Western world now finds itself in a perilous condition. It has persistently high unemployment and low economic growth, and the government sector in many “post-industrial” economies is bloated with debt and other unfunded liabilities. The politics of this situation are explosive. Governments are intensely focused on how to “kick-start” economic growth and to sustain that growth long enough to lower unemployment significantly. Economic growth is the only painless way to deal with high household and government debt, fulfill the very expensive promises of end-of-life social security and universal health care and, in the United States, finance a global military presence. The process of deleveraging or reducing the ratio of debt to income has historically been very slow.32 And there is a significant divide in expert and public opinion on the appropriate course of government action. For Keynesians, household finances would appear to be key. Consumption spending typically accounts for over 60 percent of total spending in Western economies and over 70 percent in the United States. Expenditure on new housing can range from 2 percent to as high as 6 percent. As a result of the structural changes in the global economy over the past 30 years, most households have had little or no growth in their real incomes. They have low-paying, vulnerable jobs. Many Americans have no savings cushion. They live paycheque to paycheque, and they are extremely sensitive to energy price shocks. Moreover, these households have accumulated significant debt service obligations, a large part of it for mortgages. For most households, the equity in their homes (and their automobiles) represents the bulk of their net worth. With existing home prices stagnant or falling, few families are rushing to invest in new homes. Many households in the United States have negative equity—their homes are worth less than the mortgage. Consumers are attempting to pay down debt; and home equity values, much shrunken or even negative, no longer substitute for saving or underwrite borrowing to support further spending. Businesses, although experiencing strong corporate profits and flush with cash, are reluctant to invest in new productive capacity in the face of little new North American or European household consumption demand.33 That leaves foreign trade as a possible source of economic expansion. But attempting to improve trade balances through currency devaluations or trade restrictions carries its own high risks. Not every country can improve its trade balance all at the same time. If the international competition to improve exports and reduce imports gets out of hand, then it is highly likely to be a losing proposition for all.

Chapter 2. Energy Matters  41

The combination of financially constrained households, reluctant businesses, and tricky international economic relations leaves only government to pick up the slack in demand. Yet fiscal policy in the West is hamstrung by the sudden explosion of recession-induced debt, including bailouts, and the potential for even more debt in the future as governments attempt to deliver on social policy promises. Still, many analysts focus on the need for debt relief in order to restart spending—whether it is to forgive the debts of governments in southern Europe, homeowners whose mortgages exceed the value of their homes, or young people with mounting student debt. But there is now a deep and perhaps growing political resistance to transferring the entire problem to the voting public. This is especially the case after shareholders and managements of banks have been “bailed out” and much of their questionable debt has already been transferred to central banks and governments. There remains a fundamental debate about whether the government is a big part of the solution or a big part of the problem. The public is deeply divided on this philosophical issue. Public trust in government, on all sides of the debate, has declined over the past 40 years. Oil price spikes have contributed much to this current condition; indeed, they now “trap” 34 the Western economies from being able to generate a sustained economic recovery. Just when the Western economies appear to be picking up growth momentum, oil prices begin to rise sharply. The inevitable result of higher oil prices is to further undermine household consumption spending and slow the economy again. This effect is enhanced in an economy with middle- and low-income households highly leveraged by debt and still trying to work down that debt. Consequently, the Western economies never quite reach liftoff speed before beginning to slow again with the drag of higher oil prices.

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Chapter Three

Global Energy MegaRisks: Resource Depletion, Geopolitical Security, and Climate Change The previous chapter served to illustrate the profound impact that spiking energy prices, especially oil prices, have had on the Western economies. Energy-price hikes precipitated major macroeconomic dislocations, reopened a debate about the efficacy and nature of government involvement in the economy, and hastened a profound structural shift in the global economy. Indeed, the past 30 years have witnessed the re-emergence of a renewed version of “global capitalism.” It has been manifest in a steadily increasing shift in the global economy’s centre of gravity to Asia and especially to the Asia-Pacific region and away from the North Atlantic. Trade and direct investment between the European Union and the United States and Canada still dominate the world. But the old-line Western European nations are not expected to exhibit much economic growth, and many are now mired in recession; indeed, parts of southern Europe are contending with depression-like conditions. The international political relationship between Asia, in particular China and India, and the United States now appears central to the future. The enormous and still growing population of Asia and its heavy dependence on coal as its primary fuel are the most crucial facts of the modern world. Given these still emerging global realignments, this chapter briefly outlines the nature of the risks associated with future spikes in fossil energy prices stemming from resource depletion and resource wars on the one hand and the destructive impact of climate change on the other. These might be termed mega-risks, because they are all global in scope and potentially existential in impact. Resource depletion, resource war, and climate change are the icebergs that are somewhere dead ahead, yet shrouded in deep

44  Navigating on the Titanic

complexity as to their timing and their full implications. Each in its extreme manifestation could seriously threaten the social, political, and economic fabric of all the societies that are now integrated into a global economy that is far larger than ever before.

Fossil Energy Resource Depletion The Great Income Convergence Asia and South America lagged dramatically behind Western Europe and North America in the period of the “Great Divergence” following the Industrial Revolution. But since about 1980, they have been firmly on the path of the Great Convergence.1 Indeed, economists typically assume that once a nation’s institutions are aligned with the requirements for economic growth2—including fully developed domestic markets, protection to private property including intellectual property, and open participation in global trade and investment flows—then it is reasonable to predict that a country’s average real income per capita will converge over time with that of the leading Western nations. The larger the gap in per capita income between a developing nation and the leaders of the growth club, the faster is the likely annual growth rate of the developing nation once it has joined the club.3 The United States is considered the economic and technological leader, and widely expected to remain so. Accordingly, other nations will converge on the U.S. per capita income, even as it continues to grow. The precise estimates of world GDP in 2030 or 2050 or even 2100 are not that important. They all depend on key assumptions about the share of the global population in the growth club, the developing nations’ rate of convergence on the leaders, and of course the growth rate of the leaders. These are complex issues over which it is easy for experts to disagree. And all the projections assume that there will be no calamities that disrupt the entire global economy—as we have seen, something that happened repeatedly in the first 50 years of the last century and very nearly came to pass again in the Great Recession of 2008–2009, and might still.

The Sheer Scale of Global Population The global population has now reached 7 billion people. There are roughly 1.2 billion in the developed world. Europe’s population, along with Japan’s, is expected to shrink; but North America’s could grow by another 100 million by 2050.4 On balance, the population of the developed world should hold reasonably steady. But there are perhaps almost 5 billion people who are now on a convergence path of high per capita income growth. This includes roughly 2.5 billion people in China and India and over 580 million in Indonesia, Brazil, the Philippines, and Thailand. There are another 1 billion people, mostly in Sub-Saharan Africa, not really joined yet into the growth

Chapter 3. Global Energy Mega-Risks  45

club. Moreover, the United Nations estimates another 2.3 billion people on the way by 2050, many of whom will be born in Africa. The sheer scale of this potential global income growth, and the associated demand for energy, is breathtaking.

Converging Lifestyles and Energy Use With respect to the future requirements for energy, not only the number of people but their lifestyles are important—their food intake,5 their mode of transport, their use of electricity and the size of their homes, numbers and types of appliances, and other lifestyle activities (such as travel). 6 Estimates are further complicated by different industrial structures, cultures, and population densities across nations. But one thing is certain: total energy use in the developing world, while already greater, will vastly exceed that used in the developed economies by 2035. The U.S. Energy Information Administration forecasts that energy use in developing (non-OECD) countries will increase by 85 percent by 2035, compared with an increase of only 18 percent for the developed (OECD) nations.7 The International Energy Agency foresees a similar future in that it expects 90 percent of the future growth in energy demand to come from non-OECD countries.8 Yet notwithstanding a huge increase in demand for energy in the developing world, these forecasts still imply a slowing of the growth in energy demand compared to recent experience, especially for coal consumption. However, not all experts believe that growth in energy demand from the developing world will in fact slow.9 How much additional annual energy will be required? No one knows for certain. But consider the current energy intensity of possible target lifestyles. The United States annually uses 7.15 tons of oil equivalent per capita (toe/capita) and Canada uses 7.38 toe/capita. Of course, North America is rich in fossil energy and hydroelectric resources. Canada and the United States use a lot of energy to extract and process energy and other resources, including agriculture, and both nations encompass a very wide geographic area and are sparsely populated compared to Western Europe. But even if developing nations eventually come to use the same energy per capita as the leading European states do currently, they still have a very long way to go.10 Germans use 4.0 toe/capita, the French 4.04 toe/capita, and the residents of the United Kingdom 3.26 toe/capita; all are substantially more than Asians who use only 0.68 toe/capita. Energy use in China is 1.81 toe/capita and in India 0.59 toe/capita.11 A Western European lifestyle would require more than a doubling of their current energy use per capita.

Is There Enough Fossil Energy Supply? In 2010, over 80 percent of the world’s annual primary energy consumption came from oil (32.4 percent), coal (27.3 percent), and natural gas (21.4

46  Navigating on the Titanic

percent). We know with certainty that these energy resources are finite. Accordingly, they can be, and are being, depleted. Some experts have developed a model of the use of these finite resources that can be likened to climbing a hill. Going up one side, the output of the resource is increasing year after year. As one approaches the top, the rate of increase in annual output slows and then reaches the “peak” when perhaps half the total resource available has been consumed. Thereafter one is going down the other side, and output is inevitably declining year after year. The single most important fossil fuel, and the one most crucial to the transportation sector, is oil. Peak oil has, for several years now, captured many headlines, indeed every time oil prices shoot up. Numerous authors have climbed on to this bandwagon, pronouncing imminent catastrophe.12 For many investors also, a future relentless decline in global oil production in the context of continued growth in global demand for oil has come to be an article of faith. The theory of peak oil is easy to explain and easy to understand. Moreover, it is based upon a fundamental truth. Oil is a finite resource. So too are coal, natural gas, and uranium. They are all depleting. And as economic growth becomes more globalized, the annual rate of depletion increases. But is “peak oil” a useful model? It can, for example, vastly underestimate the positive feedback effects of higher prices. As the price of oil rises, more effort is put into getting more oil out of existing pools. This can be done, for example, by injecting carbon dioxide in order to enhance field pressures and increase recovery. The largest increase in oil reserves for several years came, in fact, from increases in estimates of the economically recoverable reserves of known pools, not new discovery. Higher prices can also elicit new technologies that are helpful in discovery as well as in the extraction process. For example, 3D seismic imaging enhances discovery potential as well as lowers drilling costs; the development of horizontal drilling allows greater recovery of oil and gas from a given deposit. New technology—horizontal drilling and hydraulic fracturing—has also made it possible to access the oil trapped in the shale formations, called “tight oil or shale oil.”13 Now geological structures such as the Barnett and Eagle Ford shale oil plays in Texas or the Bakken shale—located in the area of Dakotas, Montana, Saskatchewan, and Manitoba—have sharply expanded North America’s proven oil reserves and its annual production. Beyond that, more difficult to extract resources in the offshore or lowerquality resources such as oil sands must be brought into play. Canada and Venezuela have vast known reserves of such “heavy” oil. Their exploitation requires a higher price. But as time passes, technology and knowledge change in response to higher prices and learning by doing. What was once difficult and costly now becomes less difficult and less costly. The cost of existing oil sands production and offshore oil production falls. Input costs can fall as well. For example, the recent bonanza in new unconventional

Chapter 3. Global Energy Mega-Risks  47

natural gas supply has sharply reduced the production costs of synthetic oil from Canada’s oil sands. The cost of capital has also fallen for all capitalintensive industries. While the costs are always initially higher, it is possible to extract ever more oil from unconventional—that is difficult-to-access or lower quality—oil and gas reserves.14 It is also possible to go deeper into the oceans. All of this potential, of course, is shrouded by uncertainty. In fact, anyone who is certain they can foretell even the immediate future should consider more closely the North American story around natural gas. There was a shortage of natural gas in the 1970s, which added to consumers’ woes about high oil prices. Indeed, natural gas was considered so valuable that the U.S. Congress passed a law in 1979 prohibiting its use in electricity production. The industry was deregulated in order to encourage domestic supply growth. Then in the latter half of the 1980s and well into the 1990s, natural gas supply growth exceeded demand and prices fell sharply. Industry experts expected prices to remain low. In the 1990s, the energy investor euphoria was based on the “dash to gas,” and the opening of electricity markets to new merchant generators. These projects were premised on the improvements already made in combined cycle gas turbine technology to produce electricity and the presumption that natural gas prices in North America would remain low for the foreseeable future. Then, after 1999, natural gas prices spiked again in response to higher demand and worries about supply. Many merchant generators went bankrupt. The prevailing view among experts was that conventional natural gas production in North America was at its “peak.” New supplies of Arctic gas were projected to be possibly available, along with coal-bed methane and other difficult-to-access gas reserves. But new domestic supply would not be sufficient to meet the growth in North America’s domestic demand. Imports of liquefied natural gas (LNG) from abroad were seen as essential and inevitable; investments were beginning to be made in the required docking and regasification facilities along the coasts. This was widely expected to be the start of a new investment boom in North American LNG-receiving facilities. Then, seemingly overnight, “hydraulic fracturing” changed the situation yet again, even though the basic technology had been around for some time. By injecting a combination of water, sand, and some chemicals under pressure into shale formations, it was possible to fracture the dense but still porous rock and release the natural gas trapped there. New gas supplies are now available from a variety of shale formations in Texas, New Mexico, Alberta, and British Columbia. Even some of the Great Lakes states will participate because of the giant Marcellus shale formation in the Appalachian basin. Now there is an apparent abundance of natural gas in North America, relative to current demand. Natural gas prices have plummeted as a result.

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President Obama has recently called the United States the “Saudi Arabia of natural gas.” Indeed, natural gas produced from shale formations could transform the entire global energy picture, at least for a time.15 The world could be awash in new natural gas supply. Given the inevitably large scale of such projects and long construction times, new supply comes in big incremental blocks. There is little that is smooth or continuous. And very often the new supply hits the market just as demand slackens in response to the adverse impact of high energy prices. Prices fall, only to recover later, plateau and then begin moving higher again. Only the biggest, most financially secure corporations can survive the arduous trek forward. We do not know the exact amount of each fossil fuel that the planet contains, or where all the deposits are located. After all, slightly over 70 percent of the world is covered by water and even much of the land area has not been intensively explored for subsurface resources. Estimates of proved reserves of fossil fuels are conditional not only on current geological knowledge, but also on current resource prices and technologies to mine and perhaps upgrade the resource. In short, unless we can forecast accurately both future prices and all future knowledge relating to technologies to find, mine, process, and transport a resource, we exist in a state of considerable uncertainty about our future energy supply.

Energy Is Energy Of course, the world’s energy supply is not all in the liquid form of oil. But that is not the central concern. What matters is satisfying the demand for transportation fuels—principally liquid fuels at present—and not the demand for oil.16 Oil is clearly preferred, given its physical and chemical properties and current technologies and prices to transform it into gasoline and diesel fuel. But oil is not the only possible source of these liquid fuels. Indeed, natural gas condensates and natural gas liquids already constitute an increasing share of liquid transportation fuels. The liquid natural gas fuels are similar to good quality crude oil and are produced in the extraction and processing of natural gas. Biofuels also enter the picture with a vast potential for new technology to expand liquid fuel supply, even using marginal agricultural lands. Most forecasters now acknowledge that conventional oil production may have already peaked but that future increases in “liquid fuels” will be supplied from non-conventional resources such as shale oil, oil sands, biofuels, or natural gas liquids. As noted earlier, compressed natural gas and liquefied natural gas can be used to power vehicles. There is also a well-known Fisher-Tropsch technique for converting coal into liquid fuel.17 Then, of course, there is the prospect that electric cars and trains will be the technology choice of the future. Most

Chapter 3. Global Energy Mega-Risks  49

likely, multiple transport technologies will be deployed, each specialized to its particular purpose and each using a different energy source. With the right incentive, and reasonably sure prospects of a continuing market, the required investments will be made. Energy is energy. What really matters is price and technology.

An Erratic Price Trajectory The long-run real price of fossil energy used in transportation may well rise; the absolute end point is, after all, the depletion of fossil fuels. But the trajectory of the price rise is not likely to be steep over a long period of time. Of course, therein lies the real rub. The series of short runs that comprise the long run will likely be highly disruptive. The increase in fuel supply is more likely to come in large discrete jumps, with very large and erratic price changes up, and sometimes down. This is a far more disruptive and potentially destabilizing process. A dependably relentless increase in the real prices of fossil fuels would lead to rapid and permanent changes in alternative fuel sources and in energy demand. An erratic one does not. Yet such an erratic pattern of progress is typically observed across the entire energy industry. Energy supply moves forward in fits and starts. Such is the nature of a highly capital-intensive industry, with large economies of scale and megaprojects responsible for supplying an essential commodity in a very risky global environment. Demand for energy is not responsive to price in the short run, and neither is supply. In that context, prices can explode, only later to collapse in response both to the negative macroeconomic impact on demand and to large new increments in supply. Euphoric expansion is typically followed by sober reassessment, consolidation, and a renewed focus on technology improvement and cost reduction. In the 1960s and 1970s, the euphoria centred on commercial nuclear power technology and the promise that nuclear power would be “too cheap to meter.” Instead, the industry met with stagflation, rising costs, and falling demand and then the ultimate chill of nuclear power plant accidents. The industry retrenched and vastly improved its operating performance and safety standards. It also redesigned its technology to reduce costs by reducing construction complexity, standardizing and modularizing design, and making its safety systems passive (that is, self-activating). The industry fully anticipated a “nuclear renaissance” in the West, only to have the Great Recession of 2008–2009 intervene, and then the accident at Fukushima in Japan, and then the sudden decline of natural gas prices. The nuclear chill has returned, at least in the West. The lesson is clear. No one should regard the expert forecasts as matters of fact, no matter how promising. Notwithstanding the forecasts, we continue in a deep fog about what lies ahead. It is important to understand that fundamental reality.

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For North Americans, only coal’s real price in 2010 has remained close to what it was in 1949. This is shown in Figure 3.1. Natural gas prices and, far more so, oil prices, are higher in real terms, reflecting their increasing scarcity. That could change very soon for natural gas, as a result of new technology and shale gas. No one, however, should prudently plan for the real price of fossil energy to fall continuously, particularly the price of oil and natural gas. Figure 3.1 Fossil Fuel Production Prices, 1949–2011 (dollars per million Btu) Real 17.5

15.0

12.5

10.0

7.5

5.0

2.5

0.0

1950 

1960 

1970  Coal Real 

1980  Natural Gas Real 

1990 

2000 

2010

Crude Oil Real

Source: Adapted from colour from U.S. Energy Information Administration, Annual Energy Review (27 September 2012), Table 3.1.

But does the dramatic run-up in the real price of oil foretell the end of economic growth, as so many loudly and perhaps gleefully proclaim?18 Not likely. In any case, the real social problem is in a spectacular run-up in prices, only to be followed by a crash. This creates far more uncertainty, investor chill and potential social disruption, including, as we have outlined, macroeconomic disruption. And the erratic price movement does not resolve the underlying problem of extreme dependence on fossil energy. Yet this instability is embedded in the nature of the energy industry and in the nature of market capitalism. If market capitalism fails, it will not likely be because it met a technological problem it could not eventually resolve. The real question is whether or not it gets enough time to resolve it. Each bout of

Chapter 3. Global Energy Mega-Risks  51

macroeconomic instability produces tremendous social and political stresses, which growing income inequality and high debt loads have accentuated.

Geopolitical Energy Security The fundamental uncertainties of exploration and of technology development are magnified to a very great extent by certain contemporary geopolitical facts. Specifically, much of the known reserves of oil and natural gas reside under the firm control of political regimes that are not transparent in their economic and political affairs. State-owned energy companies, for example, now dominate the global oil industry.19 Nor are the domestic politics of many of the world’s major oil and gas export regimes, particularly in the Middle East and Africa, stable. These nations typically have rapidly growing populations and accordingly a large and increasing proportion that is both young and unemployed. This does not make for political stability. But that is not the only potential source of instability. Indeed, the world’s great powers in pursuit of their own national objectives have repeatedly intervened to destabilize the domestic politics of these energy-rich nations. Thus the potential for political turmoil ranks high as a major source of risk and uncertainty in the energy business. Energy security is in the eye of the beholder. That is, it is a subjective concept. It depends on one’s taste for risk as well as one’s objective assessment of the risk.20 Moreover, there are many different types of energy security risk such as sabotage of domestic pipelines, attacks on nuclear power plants, cyber-attacks on the transmission grids that control the supply of electricity, or simply blowing up transformer stations. Energy infrastructure is also vulnerable to natural disasters such as hurricanes destroying coastal oil and natural gas facilities, or tornadoes destroying transmission lines, or earthquakes cracking open hydroelectric dams or ice storms destroying electrical distribution systems or tsunamis wiping out nuclear power plants and causing core meltdowns. Then, of course, there are the accidents caused by purely human error such as the Chernobyl nuclear core meltdown. As a practical matter, however, geopolitical energy security has come to be defined as the degree of dependence on imported fuels. It could, in principle, be about any fuel. For North Americans, however, it is about oil. The reason is simple. For the time being, North America is self-sufficient in coal, natural gas, and uranium, but not oil. Both Canada and Mexico are net exporters of oil. And although the United States is still a far larger producer of oil than both its neighbours, its 18 to 20 million barrel a day liquid fuels consumption habit makes the overall North American economy heavily dependent on oil imports.21 Figure 3.2 illustrates the highly integrated nature of the global oil market. It also illustrates the net flow of oil from both Canada22 and Mexico into the United States, and the flow of non–North American oil into both Canada and the United States.

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In the United States, oil currently represents 36 percent of primary energy consumption and 93 percent of all transportation fuels. The United States is both the world’s largest oil consumer and the largest net importer. This oil appetite and import exposure make the U.S. economy highly vulnerable to the vagaries of international oil prices as illustrated in the previous chapter. While Canada is a net exporter of oil,23 the leading economies of Western Europe are even more heavily exposed than the United States to price spikes from imported oil. In 2010, 86 percent of European Union member states’ consumption of oil was imported. Figure 3.2 illustrates Western Europe’s deep import dependence on oil from Russia, the Middle East, and Africa. The potential for geopolitical disruption in global oil supply currently centres on the Persian Gulf and Africa. The Persian Gulf in particular has important implications for U.S. and European energy policy. Indeed, the Arab oil embargo of 1973 produced a number of important changes in the energy policies of the leading industrial nations, including Japan. In the embargo’s wake, all strove to reduce dependence on Persian Gulf oil, mostly where possible by diversification of foreign suppliers. In addition, oil importing nations formed the International Energy Agency, the consumers’ counterpart to the Organization of Petroleum Exporting Countries (OPEC). Member states each agreed to develop a Strategic Petroleum Reserve, to be used in the case of another severe disruption in international supply.24 The total global reserve is now 1.5 billion barrels. This includes the United States’ Strategic Petroleum Reserve of some 700 million barrels. Oil from the U.S. reserve can be released at the President’s order. Such an order has been given on three occasions—the 1991 Gulf War; again in 2005 in response to Hurricanes Katrina and Rita; and in 2011 in response to the loss of Libyan oil production and the fragile state of global economic recovery. In the early 1970s, oil was widely used in the West to produce electricity. Then the combination of spiking oil prices and geopolitical security concerns encouraged the growth of nuclear power to replace oil in electricity generation.25 France decided to go heavily into nuclear power in order to reduce its oil dependence. Japan made a similar type of commitment, and until the nuclear accident at Fukushima, it had developed plans to increase the share of nuclear power in electricity production from 26 percent in 2010 to 50 percent by 2030. Today, France gets 75.9 percent of its electricity from nuclear reactors.26 Curiously, oil and nuclear energy continue to figure prominently in potential geopolitical conflicts. This arises from the dual nature of nuclear energy as both a weapon of unbelievably destructive power and an important source of energy for peaceful purposes. It also arises from a long history of political intrigue and war when it comes to energy resources. There is simply very little trust, and not much historical reason to trust.

Figure 3.2 Major International Oil Trade Movements, 2011 (million tonnes)

Source: Reprinted from BP Statistical Review of World Energy June 2012, p. 19.

Chapter 3. Global Energy Mega-Risks  53

US Canada Mexico S. & Cent. America Europe & Eurasia Middle East Africa Asia Pacific

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Oil and the Prospects for War The former Federal Reserve chairman, Alan Greenspan, writes: “I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil … the role of oil is still such that an oil crisis can wreak heavy damage on the world economy.”27 If Greenspan is correct, it would not be the first time that oil played a central role in war. Oil and war have been a highly toxic mix for at least a hundred years now. Oil played a central role in the two World Wars. Since the Second World War, oil has been a major factor in multiple regional wars and political intrigues in the Middle East.28 Just prior to the First World War, the First Lord of the Admiralty, Winston Churchill, convinced of an inevitable war with Germany, was instrumental in converting the British fleet from coal to oil.29 The conversion to oil provided the Royal Navy with greater speed and manoeuvrability as well as permitted refuelling at sea. But the switch to oil created a new policy problem. England had no secure supply. The public policy response was the Anglo-Persian oil company (which became British Petroleum and later simply BP) to exploit the oil resources of Persia (the modern-day Iran). The peace treaty signed at Versailles then carved up the Middle East that was formerly part of the Ottoman Empire, creating political entities to suit the tastes of the victors. These same Western industrial powers subsequently and repeatedly engaged in covert and sometimes overt actions to influence political decisions, especially in the oil-rich regions. While the First World War saw the introduction of airplanes, tanks, and motorized transport, the Second World War took the concept of mechanized warfare to a whole new level. Nazi Germany invented the blitzkrieg, to spectacular military effect. Petroleum then became the lifeblood of a highly mobile strike force for attack and counterattack. Germany could use its coal to convert to liquid fuels, but large-scale coal to liquid fuel refineries were easy targets for Allied bombers. Aside from fighting in North Africa, Germany invaded Russia in part to gain secure access to the vast oil riches of the Caucuses. Millions died. Japan had visions of empire similar to that other great island empire builder, Great Britain. Japan’s expansion into Manchuria, Korea, and then into China was followed in early 1941 with the invasion of Indo-China. The United States and Britain responded by imposing an oil embargo on Japan, by this time a rapidly industrializing society, but with essentially no oil resources of its own. The Japanese leadership faced a difficult choice. They could either accede to U.S. and British demands or get their own oil fields. The result, in December 1941, was the Japanese surprise attack on Pearl Harbor. The Japanese were attempting to cripple the U.S. Pacific Fleet in order to buy time. Almost simultaneously they invaded the Philippines, Indonesia,

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Malaysia, and the strategic port of Singapore in order to secure access to oil. With their own secure oil supplies, they had hoped to be able to negotiate a peace treaty with the Americans. While the plan was an initial military success, it was a huge political miscalculation, with tragic results in the world’s first, and so far only, use of nuclear weapons in war. The Allies would eventually win the war of course; but it was in no small measure due to the vast and secure oil supply of the United States, not to mention its temporary monopoly control over nuclear energy.

The Persian Gulf It was under President Roosevelt during the Second World War that the United States, at the time still the world’s largest producer of oil, recognized the strategic importance of Saudi Arabia. The relationship has remained close ever since, notwithstanding that the leader of the terrorist organization Al Qaida and 15 of the 19 hijackers involved in the 9/11 attack on the United States were citizens of Saudi Arabia. Moreover, the United States has developed a clear foreign policy doctrine with respect to developments in the Persian Gulf. The genesis of that doctrine owes much to the U.S. involvement in the domestic politics of Iran. The U.S. Central Intelligence Agency, along with the British Secret Service, was instrumental in the overthrow of the democratically elected Prime Minister Mossaddegh in 1953 after he had nationalized the Anglo-Iranian Oil Company. The pro-Western Shah of Iran returned to power and appointed a successor to Mossaddegh. The Shah himself was later overthrown in 1979 by a fundamentalist Islamist revolution led by the Ayatollah Khomeini. In that same year, the Soviet Union occupied Iran’s neighbour, Afghanistan. Given Iran’s strategic location on the entire eastern side of the Persian Gulf and especially on the Strait of Hormuz at its entrance, ground rules had to be articulated. In his State of the Union address in January 1980, President Carter declared: “Let our position be absolutely clear: An attempt by any outside force to gain control of the Persian Gulf region will be regarded as an assault on the vital interests of the United States of America, and such an assault will be repelled by any means necessary, including military force.” President Reagan subsequently updated the commitment of the United States to the border security of Saudi Arabia, the key producer in the region.30 The organization and the focus of U.S. military capability follows closely upon the strategic doctrine set out by President Carter. His military response to create a Rapid Deployment Joint Task Force subsequently morphed under President Reagan into Central Command, one of the unified U.S. military commands encircling the globe. CENTCOM’s area of responsibility includes most of the countries in the Persian Gulf. It is not only, however, the Middle East and North Africa that are strategically important, but also the largely undeveloped resource potential of the nations around the Caspian

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Sea—for example, Turkmenistan, Kazakhstan, Uzbekistan, and Kyrgyzstan.31 Kazakhstan also has a large share of the world’s known uranium reserves. In 2011, the world consumed about 88 million barrels of oil per day.32 The Persian Gulf countries (Bahrain, Iran, Iraq, Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates) produced about 31 percent of the world’s oil, while holding 47.4 percent of the world’s proven crude oil reserves. Saudi Arabia is the world’s largest producer at almost 11.2 million barrels per day. It is the leader in OPEC and holds the world’s largest excess production capacity—about 2 MMb/d (million barrels per day), which it can deploy to help stabilize prices if necessary.33 It did so, for example, during the Gulf War in 1991 to make up for the lost production from Iraq and Kuwait. Even today, in light of the Western embargo on Iran’s oil exports and the precarious condition of the global economy, Saudi Arabia has stepped up production. Every day the Persian Gulf countries export roughly 18.2 million barrels. Most of this, about 17 MMb/d, goes out to the international marketplace through the Strait of Hormuz between Oman and Iran. The Strait is 21 miles wide, with a two-mile-wide channel for tanker traffic going in, two miles wide going out, and a two-mile-wide buffer zone in between. While alternative overland pipeline routes are available, their capacity is limited and given their long length, their security is questionable. There is no real debate that any prolonged blockage in the Strait would have a major impact on the world’s oil supply. Interestingly, roughly 85 percent of the oil passing through Hormuz goes to Asia, principally India, China, Japan, Taiwan, and North Korea (see Figure 3.2). Accordingly, oil supplies to the West are not the major direct threat. Nonetheless, in the event of a blockade of Hormuz, the global price of oil would spike dramatically, with profoundly negative consequences for the global economy. The only question is how long the blockage would last. The Strategic Petroleum Reserve held by major importing nations would provide some buffer, and suppliers from other parts of the world may increase output somewhat. But quick resort would have to be made to military intervention.

Natural Gas in the Persian Gulf and Caspian Sea The Middle East region also has 38.4 percent of the world’s proved reserves of natural gas. In 2011, Iran possessed 15.9 percent of global proved reserves. Tiny Qatar has 12.0 percent and has become a major exporter of LNG to Asia. Russia, also bordering on the Caspian Sea, is the other large dominant global player in natural gas with 21.4 percent of global proved reserves.34 Most of its exports are by pipeline to central and western Europe. The member states of the European Union in 2011 imported roughly 65.4 percent of their annual consumption of natural gas. Germany, France,35 Italy, and Spain, in particular, are all heavily dependent on imported natural

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gas as well as oil. The principal sources of imported supply for both fuels were Russia, Africa, and the Middle East. Only Germany has an appreciable proved reserve of coal, most of which is low quality sub-bituminous and lignite—4.7 percent of the global total. Germany has recently reconfirmed a commitment to exit nuclear power generation. France, on the other hand, as noted has a large nuclear capacity and is a major exporter of electricity to neighbouring states.36 In short, collectively the nations of the European Union have a very strong strategic interest in reducing their dependence on fossil fuels, but not many obvious large-scale options, although both France and Poland could have significant shale gas potential. As far as North America is concerned, its natural gas market is still not yet integrated into the markets in Europe or Asia (Figure 3.3). As a result of this fact, plus the destruction of demand due to recession and the recent increase in domestic shale gas supply, North American prices are substantially below those in Asia or Europe. The current North American surfeit of natural gas is highly likely to result in an increase in natural gas use in electricity production. Natural gas should even find its way into the transportation sector, especially for urban specialty trucks such as garbage collection and some long-haul trucks on heavily used routes where refuelling stations can be economically constructed. At some point in the future, however, it is reasonable to anticipate that world natural gas markets will become more integrated to include North America. This only awaits the construction of the connecting pipelines, the new liquefaction terminals along North America’s coastlines and, of course, the necessary shipping fleet capable of carrying liquefied natural gas (LNG) to Asian or Western European markets.

The Strategic Conundrum of Nuclear Weapons In the years since 1979 there has been a series of wars and terrorist actions involving oil and Islamic nations—the Iran-Iraq war (1980–88); the Iraqi invasion of Kuwait (1990); the Gulf War (1991); the 9/11 attacks and the U.S. “war on terrorism” (2001–forever); the Afghan war (2001 to the present); and the Iraq war (2003–2012). Arguably the Libyan civil war (2011) and NATO’s military involvement have been partly motivated by concern about European access to oil and the enormous revenues derived from oil, as well as humanitarian concerns and a desire to promote democracy. Most attention in terms of the geopolitical stability of the Persian Gulf, for now at least, focuses on Iran. In the current situation, and notwithstanding its strategic geographic location, Iran would have very little real interest in taking any hostile action to close the Strait of Hormuz. It would make absolutely no sense, economically or militarily. One could only imagine it as

US Canada Mexico S. & Cent. America Europe & Eurasia Middle East Africa Asia Pacific

Pipeline gas LNG

Source: Adapted from colour from BP Statistical Review of World Energy June 2012, p. 29. Includes data from Cedigaz, CISStat, GIIGNL, Poten, Waterborne. Source: Includes data from Cedigaz, CISStat, GIIGNL, Poten, Waterborne.

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Figure 3.3 Major International Trade Movements of Natural Gas by Pipeline and by LNG Tanker, 2011 (billion cubic meters)

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a desperate move, taken under extreme external provocation. Iran could not possibly prevail for long in any armed confrontation with the Western powers. Nonetheless, Iran might well have nuclear weapons ambitions. The invasion of neighbouring Iraq by the U.S.-led coalition, and of neighbouring Afghanistan by NATO forces, and NATO’s recent decisive airstrikes in support of Libyan rebels indicates the West’s continued willingness to contemplate invasion if necessary and certainly some form of armed interference in domestic conflicts in this region. Of course, these interventions are not without risk and cost. The invasion of Iraq, for example, was far more costly and the benefits potentially more fleeting than most had anticipated. So Syria’s developing civil war is a complex test. Unlike Libya, there would be no low-cost intervention, even of only airpower. In the context of the West’s willingness to use military force, however, Iran’s suspected interest in acquiring nuclear weapons might be explicable. Indeed, the presence of nuclear weapons changes everything. Invasion of a nation with such weapons becomes a virtual impossibility—at least in conventional terms—no matter how superior the invading military force. No conventional army would be safe in the field. Certainly Russia’s security as a global energy supplier is enhanced by its strategic nuclear stockpile. Israel has a well-known “secret” arsenal of nuclear weapons, presumably to counterbalance the existential threat that it lives under from some of its neighbours. India (1974), Pakistan (1998), and North Korea (2006) have similarly joined the original five nations armed with nuclear weapons (United States 1945, Russia 1949, United Kingdom 1952, France 1960, and China 1964). But there is a powerful case against Iran being allowed possession of a nuclear weapon. Such a weapon would not simply protect Iran from invasion. It would dramatically leverage Iran’s strategic geographic location and greatly enhance its ability to dominate its neighbours, as well as interfere with the free flow of vital energy to the world. Accordingly, the nations of North America and Western Europe are adamantly opposed to Iran’s enrichment program for nuclear fuel, which they see as likely to proceed to weapons-grade enrichment. And they have recently enhanced their economic sanctions against Iran. Meanwhile, Iran continues to insist on its right to use nuclear power for peaceful purposes and to produce its own enriched fuel. President Obama has made it abundantly clear that a nuclear Iran is not in the strategic interests of the United States. He has also made it clear that the United States will act to prevent Iran from acquiring nuclear weapons. Sanctions and diplomacy are the preferred tools, but a “first strike” on underground nuclear facilities is not ruled out. And attacks by some unidentified nation or nations have already taken place using highly sophisticated computer viruses to disrupt the Iranian nuclear program. How this story

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ends is far from certain at this point. There could well be more geopolitically inspired oil price spikes ahead.

Asian Energy Security Energy security for Western Europe and North America naturally tends to dominate our perspective. But Asia, particularly the Asia-Pacific region, has its own increasing energy security concerns. Asia has as much, indeed far more, direct strategic interest in the Persian Gulf than does North America. In 2010, Japan, China, South Korea, India, Singapore, and Taiwan were among the top 10 oil importers in the world. They are also among the world’s top importers of LNG. The security concerns of the Asia-Pacific nations include not only the Persian Gulf and the Strait of Hormuz but also the passage to the South China Sea. Tankers loaded with oil and liquefied natural gas from the Persian Gulf on their way to Southeast Asia typically traverse yet another narrow passage between Indonesia and Malaysia—the Malacca Strait is only two miles wide. Japan’s dependence on imported oil, natural gas, and coal is well documented, along with its historic military importance. South Korea and Taiwan are also heavily dependent on imported energy. And China is now increasing its imports of both oil and natural gas. China already ranks as the world’s third biggest oil importer. It is also increasing its imports of natural gas, although this may change with shale gas production, a potentially major bonus for China.37 In fact if the current estimates prove out, then China could be a huge beneficiary from shale gas. India on the other hand appears to have far less domestic natural gas potential. Nonetheless, increasing import dependence for oil and natural gas may not be China’s or India’s sole energy security problem. As we have noted, China’s economy gets more than 70 percent of its primary energy from coal. Its double-digit rates of economic growth since 2000 have been powered by an enormous increase in its consumption and production of coal. From 2001 to 2011, China’s production of energy from coal has increased by 142 percent and its consumption by 155 percent. India gets 53 percent of its primary energy from coal; its production has increased by 67 percent and its consumption by 104 percent over the same period.38 The global proved coal reserves are ample and, as noted, they are far more spread out geographically than the proved reserves of oil and natural gas. The United States has 28 percent, Russia 18 percent, China 13 percent, Australia 9 percent, and India 7 percent of proven world coal reserves. But China consumes over 48 percent of all the energy from coal used in the world. Exponential growth rates of its economy and in its coal consumption/ production can make very short work of even hundreds of years of supply. In the past 20 years, China’s ratio of proved coal reserves to current production

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has fallen sharply to 33 years. This compares to 495 years for Russia and 231 years for the United States. The entire Asia-Pacific region is on a perilous path with respect to reserves of coal—its primary energy source. The consumption of coal in Asia Pacific is certain to continue to grow strongly even if at a slower rate than the past 10 years. China has begun to import coal and could become a much larger importer in the future. India is expected to become a much larger importer of coal both for steam purposes and for steel making. This continually growing demand, along with depletion of their coal reserves, may well begin to put international price pressure on coal as well as oil and natural gas. In short, the matter of energy security in the Asia Pacific and India could soon be front and centre for all fossil fuels. Another scramble among national economies for resources and markets may yet lie ahead, as happened in the nineteenth and early twentieth centuries among industrializing Western nations and Japan. The unexplored parts of Africa and South America and the underwater treasures of the southeast coast of mainland Asia, as well as the Middle East and Caspian Sea areas, may be the primary battlegrounds. China may choose to develop a significant naval presence in the Pacific and Indian oceans in order to protect its trade routes. Meanwhile, in a truly integrated global energy market, no consumer and no matter where located is ultimately protected from price spikes, whatever their cause. Once natural gas and coal from North America are integrated more fully into a global energy market, then these fossil fuels, along with oil, will demonstrate the same cyclical instability and potential for geopolitically driven price spikes. And coal, which has been at the core of so much global economic transformation over the past 200 years, is at the heart of yet another looming dislocation—climate change. Thanks to its coal use, China is already the largest emitter of carbon dioxide, surpassing the United States.

Climate Change: The Ultimate Problem of Public Policy Carbon is one of the world’s most common elements—found as diamonds on the one hand and tiny particulate ash on the other. It is often also found in combination with other elements such as oxygen and hydrogen. When chemically combined with hydrogen, for example, it makes fossil fuels (hydrocarbons) as well food for human consumption (carbohydrates). Coal has the greatest carbon content, which further varies with the type of coal—anthracite, bituminous, sub-bituminous, and lignite. Oil (CH2) is next with two hydrogen atoms per carbon atom. Natural gas (CH4) has four hydrogen atoms for every carbon atom, the lowest carbon content of the fossil fuels and hence now referred to as the “cleanest” fuel (or even “clean” in political speech). Burning these fuels in the presence of oxygen produces carbon dioxide (CO2), among other things.

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Carbon is also an essential building block of all plant and animal life. Trees, for example, take in carbon dioxide from the air, utilize and store the carbon, while giving off oxygen back into atmosphere. The carbon is chemically combined with energy from the sun in the photosynthesis process to make plant food (sugars)—carbohydrates. When the tree dies or is burned, the carbon dioxide returns to the atmosphere to be recycled again. Huge quantities of carbon remain stored in the soil, in the earth’s oceans, and in the biosphere—sometimes referred to as “carbon sinks.” But carbon is continuously being recycled between the earth’s atmosphere and its surface soil, its core (for example in volcanic eruptions), its oceans and its biosphere. The earth’s atmosphere is made of 79 percent nitrogen, 20 percent oxygen, and 1 percent other gases. It is in these other gases that we find the greenhouse gases (GHGs). Their percentage concentration is low—usually measured in parts per million (ppm); but their potential impact is huge. Incoming solar radiation in the form of ultraviolet (or short-wave) light passes though the gases in the atmosphere and is absorbed by the earth and the oceans. The energy radiated back is in the form of heat (infrared longwave radiation). This returning heat energy cannot pass quickly through the carbon dioxide, water vapour, methane, nitrous oxide, and other greenhouse gases; it thus remains trapped for potentially very long periods, accumulates and warms the earth’s troposphere.39 Without this warming effect, the earth would be a far colder place, covered with ice. As it is, the temperature is just right for humans to prosper, along with other animals and vegetation. Into this fortuitous cycle, however, has been introduced another important variable. The now widely popularized theory of climate change is that the activities of humans have begun to have a noticeable impact, particularly since the Industrial Revolution.40 Three human activities stand out: the digging up and burning of fossil fuels; the destruction of forests for fuel and land clearing for cities and farms; and the cultivation of the soil for human food production and the raising of livestock.41 Each is a major source of greenhouse gases, although carbon dioxide from burning fossil fuels is by far the largest. Over 80 percent of human emission of CO2 originates from burning fossil fuels, and the rest from deforestation. About half of the CO2 emitted each year is absorbed into the earth’s “carbon sinks.” The remaining amount goes into the atmosphere where it persists anywhere from 5 to 200 years. In pre-industrial times, the concentration of CO2 in the atmosphere was around 280 ppm. It has been increasing since then as a result of our economic activities. Climate models are extremely complex, and just how many degrees of warming result from different concentrations of CO2 in the atmosphere is the subject of continuing research. But there seems to be a consensus of climate scientists that a doubling of the atmospheric concentration from its pre-industrial 280 ppm to 560 ppm will lead to from 2 to 4.5˚C of warming

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(with 3˚C the most likely).42 The question then is where to draw the line beyond which we dare not go. Naturally there is disagreement about this. The concentration of CO2 is now over 390 ppm and rising rapidly as the global industrialization process proceeds. The annual rise is around 2 ppm, at our current level of global economic development. But if we take account of continued rapid growth in Asia, heavily dependent on coal as the principal fuel, global warming could be a huge problem well before 2050. The first one-degree increase in temperature has not had an appreciable impact on climate. However, it is expected that each additional degree will have an escalated impact, somewhat like moving up the Richter scale in earthquakes. There is current international agreement that the global temperature increase should be kept to 2°C or less. If this agreement cannot be fulfilled, then the impacts include melting of the world’s glaciers. In some places this would result in flooding rivers at first, followed by diminished vital water supplies. The added water would raise the ocean levels, inundating low-lying coastal cities. Adverse impacts also include insect and disease migrations into northern latitudes, not to mention more severe droughts and the potential mass migration of starving humans. Increasing severity of storms is expected as well.43 In short, we can expect a version of the apocalypse. The southern latitudes, where the most populous countries are located, will be affected more than the northern latitudes. Of course, there will be benefits in the higher latitude (colder) nations, such as reduced deaths from cold and better crop and tree-growing conditions.44 But on balance the consensus of economists working with climatologists and other scientists appears to be that there will be far larger costs than benefits, and that these costs will be borne by the far more populous parts of the globe in southerly latitudes.45 Moreover, because climate is such a complex system, one cannot rule out the possibility that various positive feedback mechanisms could scale up climate change very dramatically.46 In short, some believe that there is much more risk than we might be officially acknowledging. Not only are we facing a possible apocalyptic impact, but the probability may have been underestimated as well. In many respects, climate change is reminiscent of the dire prognosis of Malthus. And, in a bitter irony, it raises the possibility that escape from the Malthusian trap of subsistence into the promised land of the Industrial Revolution was not a permanent escape. The root cause may be of a different nature, but it is the same sources of apocalypse—famine, war, and disease—that could stalk us still. With the policies currently in place, the world is on such a path. According to the International Energy Agency’s projections, even if governments deliver on all current emissions reductions promises, the global energy-related emissions of carbon dioxide are on a trajectory “consistent with a long-term global temperature increase of more than 3.5°C.” In short,

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“rising fossil energy use will lead to irreversible and potentially catastrophic climate change.” 47 This need not happen. The good news is that the technologies to deal with mitigating the risk of climate change already exist.48 Renewable energy technologies using wind, solar, biomass,49 hydroelectric, and geothermal fuels already exist. Nuclear energy, a negligible source of GHGs on a life-cycle basis, can substitute for coal in baseload electricity production, as can natural gas, a far lower-emitting fuel per kilowatt hour, especially in combined cycle form.50 The transportation sector can be made far more energy efficient and utilize fuels other than oil. Even coal can, in principle, have its combustion rendered benign by capturing the carbon dioxide (pre or post combustion), compressing it and storing it permanently deep underground (known as carbon capture and sequestration). While experts disagree on the precise added costs, or whether these new technologies can be deployed at sufficient scale,51 these alternative energy sources are all currently far more expensive than fossil fuels in most locations, if one ignores the cost of the impact of using fossil fuels on the climate. Nonetheless, it is safe to assume that if the alternative technologies were deployed in a large scale, their production costs would decline over time. This cost reduction would be realized through the same mechanisms that have lowered the production costs of fossil fuels. Moreover, markets would eventually produce new and better technologies. The best guesstimates of economists are that to deploy existing lowcarbon technologies would lower the overall growth rates of the nations that make up the global economy. But these reductions in growth rates are relatively modest if one considers the long time frame over which the benefits (in avoided costs) would be manifest.52 In any case, the most rigorous studies we now have demonstrate that the benefits of capping the increase in the global temperature outweigh the costs by a substantial margin. The only empirical issue is how big that margin really is.

Conclusions: Peering into a Future Shrouded by Fog The dominant prognosis for global economic growth is that the twenty-first century will necessarily be dominated by the continuing economic success of Asia, as well as South and Central America where a similar incomeconvergence process is underway led by Brazil. The Chinese and Indian economies will come to equal, and even surpass in absolute size, the North American and Western European economies. The Chinese already have the second-largest national economy in the world. Of course, the path ahead for the developing economies is unlikely to be smooth. For China, there is constant domestic political pressure to raise living standards, reduce pollution, and spread economic growth regionally, as well as to address international demands to rebalance its trade surpluses.

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Even more fundamentally, however, this assumption of continued growth in its income per capita depends profoundly on China’s and indeed Asia’s access to the needed energy supply. This is not assured. Spectacular growth in energy demand from many billions of people in developing countries for finite fossil energy supplies elicits forecasts of inevitable, relentless, and dramatic increases in the real price of energy. What is far more likely, however, is an erratic pattern of large price increases followed by crashes, retrenchment, and then a leap higher again. This erratic forward trajectory is dictated by the basic economics of a highly capital-intensive industry with large economies of scale and profound risk and uncertainty in both supply and demand. But in many respects, such a price trajectory is more problematic than a steady increase in price. The erratic price trajectory entails far more dislocation, as well as a less consistent and certain incentive to find alternatives to fossil fuels. Much of Asia Pacific in particular, far more than North America, also confronts an energy security problem. Continued Asian development will suck ever larger quantities of oil, natural gas, and even coal into international trade. As it does, the potential for geopolitically inspired disruptions in supply will increase in corresponding fashion. China and India are both likely to increase their coal imports, as well as their imports of oil and natural gas. An important share of those imports in the future could also come from the United States and Canada. Although exports from North America will diversify the energy supply to Asia, they will diminish the insulation of North American consumers to spiking global energy prices. The prices of natural gas and coal are highly likely to show the same dramatic price spikes as has oil. Frequent energy price spikes are not all that may lie ahead. The economic growth of the entire Asia-Pacific region, especially China, is heavily coal dependent, in much the same way that the Industrial Revolution was coal based. This raises another global risk: climate change. The growing scientific evidence of global warming caused by human activities is, in some ways, the darkest cloud on the horizon. Although a relatively recent concern, global warming has been building as a potential problem since the Industrial Revolution. A warmer climate will melt ice formations on land, raise oceans, change weather patterns, and possibly increase the severity of storms and extreme weather events. Current estimates of the future costs far exceed the benefits, even at current levels of greenhouse gas emissions. Our use of fossil fuels and also our agricultural practices are at issue.53 Coal use is the worst offender. These mega-risks threaten our global civilization. It is a great irony, of course, that food and fossil energy are the very factors that have made our escape from subsistence possible in the first place.

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Chapter Four

Why Private Organizations and Markets Fail It is not too difficult to conjure truly calamitous breakdowns of our modern economic, social, and political institutions. Spiking prices of fossil energy and food energy will create frequent recessions and further squeeze the living standards of low-income households—with no prolonged incentive to resolve the underlying problem. This situation could easily and quickly undermine social and political stability around the globe. The profound changes currently underway in the Middle East—the Arab Spring as it is popularly called—are perhaps a recent illustration. But even democratic political regimes may be no less stressed in the future if energy prices (including food) rise sharply. A growing cadre of poor and near poor, amidst spectacular accumulations of private wealth, might be sufficient fuel for a social explosion. Our modern populations are concentrated in large cities. Rioters in Athens, London, Paris, or Madrid are responding in part to the economic pressure cooker that joblessness and the rising price of basic necessities create.1 Among developed nations, Western Europe is now particularly vulnerable to spiking energy prices. It may well be the canary in the mineshaft. It is also equally possible to imagine a future world ripped to shreds by global war, as an energy-resource-starved Asia Pacific squares off against resource-rich nations in the Americas, the Middle East, and Russia. The fact that war between nuclear armed nations would be catastrophic for all—even suicidal—does not make it impossible. Global commerce was interrupted once before by the colossal tragedy of the First World War—at the time, an equally unthinkable outcome of the international competition between nation states. True, nuclear weapons make the stakes far higher and therefore nuclear war far less probable—so-called Mutual Assured Destruction (MAD).

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Unfortunately, the advantage that nuclear weapons confer in freedom from conventional attack, and therefore greater freedom of action internationally, are too obvious for any nation not to notice. Therefore, there is a clear incentive to develop nuclear weapons capability. Equally unfortunately, however, the proliferation of such weapons increases the risk of an initial detonation followed by a quick series of miscalculations by the major powers, ultimately escalating into to a full-scale nuclear exchange. War, even where it appears to be limited to a specific region, has potentially viral properties and can quickly scale up. And there is no guarantee that a future instrument of mass destruction, a biological weapon for example, will not be monopolized long enough to entice its use. Similar dire forecasts of weather-related destruction of infrastructure and crop failures inspired by climate change are not uncommon. Many of the global megacities are on ocean coastlines and/or dependent for their water supplies on major rivers, often fed by glaciers. Global warming invites the spectre of potentially catastrophic social and economic collapse around the globe as glaciers melt, rivers run dry, oceans rise, and weather becomes more extreme. Armed conflict on a regional or even global scale is a possibility in response to the political stresses and potential mass migrations induced by climate change. The growing mass of humanity in Sub-Saharan Africa may be further afflicted by drought and disease. Doomsday scenarios are well documented in popular books, movies, and media coverage. However, these are not simply the imaginings of Hollywood. Powerful and reputable mainstream organizations such as the Pentagon, whose job it is to build plausible scenarios for future conflicts, take seriously the potential for global conflict inspired by the local effects of global warming. These risks—one might call them mega-risks—are global in scope and possibly existential in impact. When a society fails, it may do so by succumbing to external military attack, defeat, and withdrawal from territory, or to internal socio-politicaleconomic breakdown. Or societal failure may result from some environmental catastrophe that also gives rise to both of the above. Once a breakdown begins from any of these sources, it may be impossible to predict where it will end. Viral effects may apply. Complex systems—a society such as our own, for example—can exhibit such dramatic and essentially unpredictable outcomes. In part this is because in complex systems, with many non-linear relationships, events can scale up very quickly into something with a huge impact. Even a seemingly inconsequential event could, in principle, unleash its own powerfully amplified or multiplied effect.2 It is a form of explosive contagion. The hugely popular book The Tipping Point by Malcolm Gladwell vividly illustrates the sociology of such events. This is also a central feature of what Nassim Taleb has called the “black swan”—essentially unpredictable and small perturbations with a gargantuan impact.

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But surely our institutions are capable of comprehending these risks and therefore of taking concrete actions to minimize their probability? Can our private or public institutions act to forestall future crises? It is to this crucial question that we now turn.

Why Private Organizations and Markets Fail In his book Collapse: How Societies Choose to Fail or Succeed, Jarrod Diamond documents how societies that fail typically do so because they exhaust their environmental resources. He then offers four reasons why some societies make such disastrous decisions: “failure to anticipate a problem, failure to perceive it once it has arisen, failure to attempt to resolve it after it has been perceived and failure to succeed in attempts to solve it” (438). Diamond provides some, but not extensive, discussion about these possibilities. Most of his book is devoted to detailing historical examples of failed societies, and to outlining our own current environmental challenges— everything from habitat destruction, depletion of wild fish stocks and fresh water supplies to the spread of toxic chemicals and global overpopulation. As a result, Diamond does not make it perfectly clear who the decision maker is that he is discussing. Who is society? Who makes the fateful decisions and why? For our purposes we can assume that in our own society the crucial decision-making institutions are made up of private corporations operating in reasonably competitive global markets, and individual households also operating in those markets, both of which operate through our democratically elected governments (federal, state/provincial, and local). The decisions we confront will be made within the confines of the institutions we have constructed, as outlined in chapter 1, and in the economic context outlined in chapters 2 and 3. This chapter focuses primarily on private decision-making in the context of largely private markets.

Complex, Unpredictable Futures Diamond’s first case seems straightforward enough. In this instance, private decision makers do not see a problem coming. They are literally “blind-sided” by future events that are unknowable or unpredictable given the current state of knowledge.3 Of course, humans are in some senses always in a fog about the future. Our inability to predict technological change or market panics is an important source of surprise in the economy; but political events such as war or revolution, geological events such as earthquakes and tsunamis, and severe weather events such as droughts, hurricanes, or tornadoes are most often beyond our predictive powers as well, at least with respect to precise timing. Who predicted the recent tsunami and related devastation in Japan? Who could have predicted that a protest act of self-immolation by a street

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vendor in Tunisia could produce vast political change not only there, but also in Egypt, Libya, and Syria? In this regard, it would be fair to say that our forecasting capability has always been, and remains, highly limited when dealing with complex systems—in short when dealing with most of social, political, and economic life as well as with geological and weather-related events. But this is not a limitation of our institutions, or how they make decisions; it is simply a limitation of our understanding of causality, our mental models of how things work and accordingly of our ability to forecast events or to peer into the future. There may be many of Nassim Taleb’s “black swans” awaiting us. A variant on Diamond’s first case, however, and one perhaps closer to our typical experience, is that some people or groups in society actually do foresee a problem. In this instance, the forecast event may not be a totally random occurrence but simply one considered by a majority of people to be of low or very low probability. Yet some people may reasonably foresee that communities built below sea level or at sea level on ocean coastlines, or on the sides of mountains, or on geological fault lines, or on flood plains, or in the middle of forests or in semi-arid locations will invite natural calamities—even if it has not happened for a very long time. And there were no doubt a few people who predicted most of the great political events and calamities of our time and earlier—the Second World War, the collapse of the Soviet Union, the current troubles of the Euro zone, nuclear accidents, the sub-prime mortgage crisis, and so on. The issue here, however, is not so much the nature of the forecast but of what people do with these forecasts. One of the great institutional strengths of a system of private markets and corporations is that they function on the basis of the knowledge and wisdom of anyone and potentially everyone. Anyone can independently respond to a forecast by making his or her own provisions to survive or benefit from the expected event. Forecasts of fossil fuel depletion or even geopolitical interventions to interdict supply fit this situation. Those who foresee the potential problem may begin to make whatever provisions are necessary for their personal survival or benefit. As noted, private markets allow this possibility. One does not need to wait for a government or a popular consensus before one acts. Following the nineteenth-century insights of Malthus, Ricardo, and Jevons, many current investors are making such bets on the ultimate finite nature of fossil fuels, arable land, or potable water. Other investors may be betting on a technological fix to these potential resource constraints. Yet others may anticipate a global population collapse. If any of these investors are wrong in their forecasts, however, then they lose their investment. That is the way private markets work. In summary, the failure to forecast correctly—to the degree accurate forecasting is even possible4 —is not likely to be a systemic weakness of our private markets and organizations. In fact it is probably one of their

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strengths, since the participants, at least the corporate ones and the very wealthy households, are highly motivated to employ the best possible models and forecast techniques. Unlike government forecasters, they typically have their own money at stake. Nonetheless, the potential availability of a private salvation does not constitute a solution for society. Moreover, if the calamity striking society is overwhelming enough, there may be no individual salvation possible. When the herd starts to stampede or is dying from a virus or is attacked by an overwhelming force, there may be no individual sanctuary. And a collective problem can arise when a private forecast proves largely correct, but the rest of the human herd did not prepare, either because they did not believe the forecast or were not in a position to make hedging provisions, even if they did believe it. A vast majority of households, for reasons outlined above, may find they are unable to hedge. Instead they behave myopically, focused only on the present. Strictly speaking, this is not a failure of the design of our private organizations or markets. But, as we have seen, energy is a commodity that is so central to modern life that a sharp increase in its price can have a huge macroeconomic impact. This is perhaps particularly the case with oil because it so completely dominates transportation fuels; and personal transport fuelled by gasoline, diesel, and jet fuel has become so central, in particular, to North American lifestyles. Oil supplies 93 percent of all transportation fuels used in the United States, and 36 percent of all primary energy consumption.5 It is the scale or magnitude of the impact that makes an oil price increase a social problem. It affects virtually everyone, everywhere in these societies. A large price spike for any other non-energy commodity would scarcely be noticed. But energy is different. A price spike can lead to prolonged unemployment and associated suffering. We have had, as outlined earlier, plenty of experience in this regard. Nonetheless, households in general do not prepare for such eventualities, but have come instead to depend on governments to engage in countercyclical fiscal and monetary policy. There is clearly an element of moral hazard here. We are perhaps not surprised that the vast majority of households, unsophisticated in their economic forecasting and decision-making, act myopically, pursuing only their current interests. But there is a similar type of problem that can befall private corporations. Forecasts might be ignored if decision makers do not bear the full consequences of their decisions. In such circumstances, private individuals and corporations may be inclined to override the knowledge embedded in a forecast. In short, sometimes a high-probability forecast of an iceberg dead ahead can be overridden by a more compelling consideration. Even private corporations might become “trapped,” locked into a behaviour that is known to be potentially destructive. And it can happen to the most sophisticated of modern corporations. The sub-prime mortgage crisis illustrates.

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Ignoring Warnings: The Compelling Need to Get Up and Dance In the epilogue to his book The Age of Turbulence, Alan Greenspan writes, “The upheaval in world financial markets that began in the summer of 2007 was an accident waiting to happen” (507). Of the private institutions participating in the making of the financial crisis, Greenspan observes that “a difficult problem is that much of the dubious financial-market behavior that emerges during the expansion phase is the result not of ignorance that risk is badly underpriced, but of the concern that unless firms participate in a current euphoria, they will irretrievably lose market share” (521). In short, ignorance of existential risk is not the problem! The problem is embedded more deeply in institutional design. The profit motive coupled with the existence of competition drives each participant institution forward. It is difficult, if not impossible for an organization, or more precisely its leaders, to stand back calmly and coolly from the rush of the competitive crowd that measures success by outcomes—in this instance short-run or quarterly “profitability.” Greenspan quotes one Wall Street executive as saying that they were compelled to “get up and dance”—that is, to participate in taking on ever more sub-prime mortgage risk—or they would lose market share! In the standard textbook understanding of how capitalism works, this behaviour is not supposed to happen. Corporate leaders do not knowingly “bet the farm” just because others appear willing to take reckless bets. Greenspan himself argues that he resisted more regulation of private corporate behaviour because he believed that rational actors would not knowingly jeopardize their own organizations. They would not knowingly roll the dice on an existential bet. Unfortunately, there are other features of current institutional design that can encourage such behaviour. These all have an element of “moral hazard” at their core. One is that senior managers in charge of the enterprise can earn enormous bonuses, in the many millions of dollars, based on current corporate profits. The fact that such behaviour may lead to a longer-run catastrophe for the corporation is not the dominant consideration to the actual decision maker. Corporate executives are not the owners, even if they have a significant share of ownership. The current executive leaders are rewarded, and socially applauded, only for current profitability. Past performance is quickly forgotten. True, stock value resides in expectations of future performance. But expectations of the future are heavily weighted by the present, especially by the direction and momentum of profits and stock prices. Moreover, executives are not held accountable for future performance, if those potential outcomes are far enough out in time. No executive decision maker is required to pay back monies that have already been received, except perhaps in the case of outright fraud.

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In short, there is a potential disconnect between benefits and costs that leads to a powerful immediate incentive to “make hay while the sun shines.” There is nothing to connect individual actions by a chief executive to “distant” future outcomes. And there is no “social disapproval” if everyone in the group is behaving similarly. It is simply expected and applauded behaviour in one’s own social circle. Social disapproval only kicks in after the catastrophe, and seldom has any legal implications.6 Formal risk management in any hierarchical organization, no matter how competent in a technical sense, is still subordinate to the taste for risk embedded in the top leadership of the organization. What distinguishes all leaders, virtually by definition, is that they have been successful in the past. That means they took risks and the outcomes were positive, even if those outcomes were highly improbable and unrelated to those leaders’ actions or their natural talents. Being “Masters of the Universe,” such leaders do not yield easily. It is not that mindless euphoria cancels out knowledge of risk, but that institutional design, competitive instinct, and the personal experience of success locks participants into an imprudent gamble. In the case of Wall Street moguls, according to Greenspan, they were convinced “that they could keep adding to their risky positions and still sell them out before the deluge.”7 In a game of musical chairs, natural leaders do not typically assume that when the music stops, they will be the one left without a chair! In principle, the board of directors of a corporation should be watchful with respect to the long-run interests of all shareholders. The board then should be able to rein in an overzealous management. One problem, however, is that the board itself is composed of individuals who are simply “agents” of the shareholders, and modestly paid ones at that when compared to senior management. Moreover, in many cases the board may be beholden to senior management for their appointment in the first place. But, more fundamentally, the senior management always has more information about the true state of affairs than the board or the ultimate owners. It is, after all, the management’s full-time job to run the company. Another reality is that board members themselves may be subject to the same “group think.” They cannot, any more than government regulators, think outside the prevailing conventional wisdom. As we have noted earlier, even Adam Smith warned against joint stock companies—the early forerunner of the corporation—and the possibility of agents running amok. Surely, then, shareholders will pay attention. After all, it is their interests and wealth that are ultimately being put at risk. But even if they do pay attention—although as Adam Smith noted, many do not—it is not always clear in a widely held, publicly traded company what the shareholders want. They have limited liability, and they too may be interested in maximum immediate returns. This is especially true of the momentum investors who buy in for only a short-term ride up. They are not the long-term, patient “value”

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investors, but their willingness to trade gives them significant impact on current stock values. Short-run increases in profits increase stock prices, with no necessary correlation to long-run profitability. This can be reinforced if the corporation itself is highly leveraged by debt. In that instance, the shareholders are betting with a lot of other people’s money. Momentum investors might easily make a giant profit and exit before disaster strikes. Limited liability and debt create a “moral hazard” that increases with the increase in leverage. While debt is a lubricant of capitalism, it can easily grease the skids to disaster. In the specific case of financial institutions, there were other important institutional flaws.8 But a final and perhaps overriding institutional flaw is contained in the notion of “too big to fail.” As we have seen, when institutions reach some critical scale in their role in the economy, it has become conventional wisdom that they cannot be allowed to fail because of the collateral damage that this can cause. They are “too big to fail.” The need to rescue them is not the invention, however, of “free market capitalists.” This is the outcome of modern Keynesian beliefs, coupled perhaps with the fact that governments can become captured by special interests. Of course, if the investors in such an institution know their status as “too big to fail”—and how could they not know it—then they are encouraged to take even larger risks. Such is the nature of moral hazard on a grand scale. Alan Greenspan himself was famous for his “Greenspan put” as chairman of the Federal Reserve. The major players in the financial industry could be reasonably confident that the Federal Reserve, with Chairman Greenspan in the vanguard, would ultimately ride to their rescue with easy credit to get them through any credit crunch. In short, what is not supposed to happen in a perfectly rational private enterprise can happen when the motive of personal gain is pursued in a competitive, risky, and uncertain context where there is a good deal of moral hazard embedded in the institutional design. Betting with other people’s money or taking risks when the gains are privatized and the losses socialized does not make for prudent behaviour, but it does underwrite arrogant and aggressive behaviour.

Cognitive Limits Diamond’s second cause of societal collapse is almost a subset of the first. In this instance, a society “fails to perceive a problem, even after it has arrived.” This is not substantially different from the failure to forecast; the problem has already arrived, but it is still below the community’s social radar screen. It does not initially present itself as a material threat. Perhaps it is a Trojan horse, appearing first as a gift. Our use of fossil fuels has had that quality. There are obvious and enormous benefits from the use of these fuels. But there are also adverse health effects from smog created from burning them

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in the manner that we have. Of course, these adverse effects were not immediately known or understood. And even dangerous air or water pollutants may initially be of such low concentrations as to be relatively benign. In this instance, the inadequacy of the decision maker is not in lack of foresight so much as in faulty perception. Diamond’s own example is climate change that is gradual. He argues that gradual global warming is concealed to our everyday experience by dramatic year-to-year fluctuations in temperature, both up and down. Humans just get used to a trend change that is gradual, even though the global temperature is trending relentlessly higher, with potentially catastrophic effects. He calls this collective misperception “creeping normalcy” or “landscape amnesia” whereby the change is so subtle over time that no one can remember the prior landscape. We do not realize we are falling, not flying. The decision-making entity in this case is unaware that there are other costs associated with its actions. These costs are not perceived. There is nothing in this example, however, to suggest that private markets or individual or corporate decision makers would be more susceptible than governments to this type of perception problem. Indeed, as I will argue in the next chapter, it may be more of a problem for governments. But it is true that private corporations will not be motivated to even ask the question, “Could this be harmful to others, even if it is legal and does not seem like a problem?” The corporation has been granted limited liability in any case. A society, of course, can grant itself no such privilege.

Knowingly Courting Disaster The third societal failure Diamond identifies is the failure to address a problem even after it has been perceived. This is the more interesting case because it would appear to be embedded not in the problem and its technical complexity, but in the institutional makeup of the society itself. It is not a problem of faulty forecasting or of perception. The society knows it is headed toward disaster, but cannot avert from it. But what type of decision-making institution would lead to such an outcome? In this most interesting case, Diamond moves into a terrain much travelled by modern economists. This is precisely the moral hazard problem in a slightly different guise. In this case, there is a clear social cost that exceeds the private cost of the action, but no mechanism by which to get the decision maker to take that into account. Diamond’s third case of the failure of social decision-making fits neatly into the “market failure” paradigm of economics. It is the “market” that is the ultimate societal decision maker. As noted earlier, in the simple idealized version of the market, the market can “fail” to produce the maximum social good if and only if one of its key governance features is violated—for example, if some players collude and form monopolies; relevant information is not equally available to both buyers and

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sellers; or private individuals and corporations in their pursuit of income and wealth do not bear all the costs or receive all the benefits of their actions. In the latter case of benefits and costs not all being received and borne by the decision taker—for example, where social costs exceed private costs— individuals and corporations will knowingly deplete wild fish stocks, pollute the air, and despoil the land or the forests held in common. Economists refer to this as a “negative externality,” an adverse impact on another party for which there is no associated compensation. This outcome has also come to be more popularly known as the “tragedy of the commons.” In fact, in the presence of commonly owned resources, individuals will have an incentive to harvest as much as they can before others deplete the resource first. Climate change related to our global clearing of forests and our global use of fossil fuels is merely a globalized version of this potential abuse of our common environment. No private decision maker, anywhere on earth, is compelled to take account of the net negative effects on the global climate of his or her decisions to clear trees or emit greenhouse gases. Accordingly, decision makers will not refrain or stop themselves because they have no individual incentive to do so. In this instance, societal decision-making through the private market fails miserably. It cannot stop an impending disaster before it happens, even in the face of certain knowledge that it is happening or will happen. Whether it is called a moral hazard or a negative externality, it is generically the same problem. Private corporations acting on their own—no matter how large, global in reach or technically sophisticated—will not solve this type of problem. They will have a profound “blind spot” when it comes to such problems. Environmental problems, where water and air are treated as common resources, and therefore mistreated, are the classic failures of private organizations and markets. But to these we must add a new potential source of failure that is somewhat more complex.

A Profound Faith in Technology and Markets, But Diamond’s fourth case seems equally straightforward as the first, except that a society now correctly foresees the problem and tries, but fails, to overcome it. There is no institutional failure here, but simply a problem that overwhelmed the resources of the community. No doubt there could be a classification of typical reasons for failure, covering a multitude of different, potentially existential, societal problems. But Diamond does not offer one. Consider, however, a society such as our own that is designed specifically to facilitate the creation of more and better tools. Such a society may well foresee the potential for a problem, but by virtue of its decision structures delay its response because it has a profound optimism in its ability to respond if a problem actually materializes. This is a society that does not deal

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with forecast problems but only responds to actual ones. And even then, it engages only for as long as the problem seems to persist. North Americans do appear to have a deep and profound faith in technology as a potential saviour, even employing technologies not yet created.9 We also have a profound faith that private market decision processes will bring the needed technologies into being and into widespread use. Private markets are not only our early warning system in this regard, but also our incentive system for change. Prices rise first in futures markets. If these futures are confirmed, then this fact changes both our current behaviour and our tools or technologies. It is this matter of faith in technology and the operation of markets that often separates the modern-day Malthusians from the pure market economists.10 The Malthusians of today believe in physical resource limits to economic growth, while most economists have faith in markets and technology.11 Why should they not have such faith? After all, the combination of markets and technology has been the essence of the success of capitalism for the past 200 years. That success has far outpaced anything achieved in the many thousands of years of previous human history. It is true, of course, that the current global economy is overwhelmingly dependent on non-renewable energy supplies and that these are depleting. Entropy adds a further loss. Any attempt at unlimited economic growth based on such fossil fuels and uranium will ultimately confront the physical fact of finite supply. Other things being constant, growth must cease as the eminent economists Thomas Malthus and David Ricardo accurately foresaw over 200 years ago, and many others have predicted since. In the endgame, no one makes out well, except perhaps the owners of the finite resources of fertile land, energy, potable water, and other key minerals. As noted, many current investors are making such bets on a global basis. But of course other things do not remain constant. How can we be certain that technology will not rescue us as it has done, arguably with accelerating force, in the past 200 years? True, no technology can reconstitute the fossil energy that we have already consumed. That inheritance is constantly and forever being diminished. But technology experts forecast exponential growth in human technology, pointing to the evidence of Moore’s law in computing in which the price of computing power falls roughly 50 percent every 18 months. A globalized economy adds a further benefit. Billions of educated people, integrated into global networks, each innovating to respond to different local conditions could throw up a vastly more robust array of new technologies and productive ideas than ever before in human history. If we isolate the immediate energy problem as a diminishing supply of oil, then solutions are already available: find more oil;12 find an oil substitute such as electricity or natural gas and biofuels; reduce our transportation needs;13 make our transportation vehicles far more fuel efficient.14 Private markets will work on all of these fronts simultaneously and in ways that it is

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impossible for one observer to catalogue or to fully anticipate. The market solution is not easy to predict because it will likely involve a multitude of different actions and potentially many “surprise” solutions. A market solution is not certain, but it has happened on a systematic basis in the past. It is this experience that provides the basis of our “faith” in the future of technology. Still, “faith” is the correct term here.15 We are just hoping for the best. Yet there are potentially several important institutional flaws even in this story. The first is a long-standing issue when it comes to private markets and knowledge, and more specifically new knowledge embedded in new technology. Private markets will “fail” to provide new knowledge. Private enterprises will underinvest in new scientific and technological knowledge because investors cannot reap all the returns from such investment. There is simply too much risk that nothing of commercial value will be discovered, or that if it is, the knowledge will somehow leak out to others. Moreover, private markets will only address those technology needs backed by financial resources. They will not develop unique technologies to address the needs of the poor or the dispossessed. Accordingly, the potential squeeze on low-income North American households from a future increase in energy prices is not a market problem. No one is willing to pay, as yet, to deal with it. Of course, the patent system which grants a government-mandated monopoly—itself a necessary but major departure from the market paradigm—is designed to address the fact that knowledge creation is a “public good.” But the system is not perfect. Information still leaks to competitors as part of the patent process. In a global economy, those competitors may be citizens of jurisdictions that do not protect intellectual property as rigorously as in North America, or at all. The modern global economy is filled with cyber-theft. Will our protections to intellectual property provide the same incentive in a global economy, but without a global government that can be trusted? And what if further investments in our research and development bureaucracies are subject to rapidly diminishing returns?16 In the energy sector, there is a related but additional problem of very high initial capital cost required to build prototype facilities before full commercialization of some technologies. New nuclear facilities and state-of-the-art coal facilities with carbon capture and storage are examples. Building “first of a kind” plants is fraught with risk. The technology, construction, operating, and political risks are such that private companies are not willing to invest the billions necessary to demonstrate commercial feasibility. Most technology experts vastly overestimate the commercial potential of their preferred technology. Such is their faith. Investors know this. In these instances, private enterprise is disinclined to take the hundreds of millions or billion-dollar risks. It could be because they prefer the government (the society) to take the really big risks such as investing in basic science and the development of very new, very expensive technologies. Or it could

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be in part because a large segment of the energy industry is dominated by regulated monopolies. Much of the electricity production and most of the transmission and distribution of electricity and natural gas fit this description. There is little incentive to innovate. Accordingly, these energy firms spend comparatively very little on research and development.17 A further problem, although not one generally acknowledged, is that market forces operating on their own are not instantaneous. Private markets attempt to solve only the problems that they have a clear and reliable incentive to solve. They do not solve forecast problems until prices actually begin to increase. Indeed, the market will not begin to work aggressively on the matter until energy prices not only rise but are persistently higher, and expected then to remain so. In a capital-intensive business, it takes time, and the actual experience of persistently high prices, before major action commences. The existing capital infrastructure of society is long lived; although the private market is a miraculous device for the diffusion of new technology, it also uses up time. Truly transformational technologies have always taken time to get market penetration. Historically speaking, we do not, in fact cannot, change our capital infrastructure instantly. The entire community is not mobilized in an instant—as it can be in war by government decree. In wartime, car factories are transformed almost overnight into armoured-vehicle factories. This is not the manner of peacetime capital transformations through private markets. The open question, therefore, is always whether the problem confronting us is one that provides enough early warning in order for private markets to respond in sufficient time to avoid catastrophe. There is another and even larger problem. Private markets will still have a “blind spot” when it comes to technologies that have positive environmental attributes such as low carbon emissions. Energy is an undifferentiated commodity.18 Households, as with corporations, typically care only about consuming the lowest cost energy unless compelled to take account of the environmental impacts of its source. The energy market in most countries does not yet distinguish between primary fuels based on their carbon emissions. Accordingly, producers will not deploy low carbon emission energies or innovate to reduce carbon emissions until they have a persistent and seemingly reliable price signal as to its value. They have no incentive to do so. The fossil fuel industry dominates the energy sector of our economies. It accounts for over 80 percent of global primary energy supply. It generates enormous amounts of income, some of which is potentially available for investment in new energy technologies. But the industry itself has an attenuated incentive to invest in alternative energy sources. It will not knowingly and willingly cannibalize its own assets and technologies. North America is a leading producer of oil, natural gas, and coal. The private interests that control this sector of our economy will do only what is in their interests to do. They are not expected to do otherwise.

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Conclusions Some things are so complex that they prohibit the possibility of highly accurate forecasts. We must await the development of more accurate models. But private corporations, operating in private markets, have no evident systemic weakness with respect to forecasting that which can be forecast. In fact, if they act on their forecasts, then they are highly motivated to be as thoughtful as possible. Nor does it seem likely that private enterprise is especially prone to suffer from the “perception problems” referred to by Diamond. Nonetheless, private corporations operating in private markets might fail spectacularly in the presence of moral hazard. As we have outlined, they knowingly courted disaster in the case of private financial institutions and sub-prime mortgage lending, because they had good reason to believe that governments ultimately would bail them out. They believed that the downside costs would be socialized, that is, borne or at least shared by others. The same problem of decision makers’ not bearing the full costs or benefits of their actions afflicts private organizations and competitive markets in respect of environmental problems. In this instance, they will knowingly court environmental disaster. They have no incentive to do otherwise. And then there is the problem of the macroeconomic impact of an energy price shock, an oil price shock in particular. This is not a systemic flaw in private markets. Private households could in principle make provisions to deal with such eventualities. These problems are, after all, not exactly in the category of a “black swan.” Energy price spikes and recessions have happened several times before. And yet many, if not most, private households and businesses do not prepare. Because this behaviour is so prevalent, energy so important, and the time it takes to adjust so prolonged, it becomes a social problem. Households and businesses have come to expect governments to act to remedy the problem, whatever its proximate cause. This is also a form of moral hazard. When it comes to technological diffusion, it is hard to argue with the institutional design and proven historical success of a system of private, competitive markets. The result is that we have come to have a profound faith in technological solutions to future problems, if and when they arise. But private markets have well-known weaknesses when dealing with the creation of new knowledge. They need monopoly returns, which may not be forthcoming in a world filled with industrial espionage. And our bureaucratic research establishments may be subject to rapidly diminishing returns to more investment. Moreover, such knowledge will only be sought when there is an immediate reward for doing so. It will not be sought in a systematic fashion simply in anticipation of future problems, especially of future problems of those unable to pay. Private markets only respond to a clear and persistent rise in prices, not to a mere forecast of higher prices. Energy projects involving billions of dollars are not initiated unless there is a clear and compelling case for them.

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We have faith that our private institutions will invent the technologies we need when we need them, if not before. But because of the lag time for the invention of technical solutions and their widespread deployment in society, the question really becomes, How long we can endure any future calamity without societal collapse? Can our social and political institutions make it to the long run? Maynard Keynes felt that it was an abdication of responsibility to argue that it will all work out “in the long run.” As he wryly noted, “In the long run, we are all dead.” No one, of course, expects private industry to attempt to avoid war between nation states. That is obviously a government or societal decision. Yet the pursuit of private interests might clearly lead the entire society into war. Global enterprise, since its inception, has always entailed this possibility. It was not by chance that England, an emerging economic powerhouse with a global mercantile empire, also possessed a great and formidable navy. The protection of property beyond one’s own territory is a widely accepted duty of the nation state. In these matters, someone else in society always bears at least part of the downside risk to private enterprise. In short, our private organizations are not inclined or have no incentive to deal with the energy mega-risks that we confront. They typically wait until the enemy is at the gate—assuming there is a gate. In effect, the crisis has to be upon us before private markets go all out on the solutions. But of course private corporations and households operating in private markets are not the only decision-making entities, even in those capitalist societies where private institutions predominate. It is to the decision-making capabilities of national governments that we must now turn—to our modern democracies, specifically as practiced at the federal level in the United States (and Canada). Can they act to forestall a disaster, before it happens? Can they act pre-emptively and decisively in the face of potentially calamitous futures?

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Chapter Five

Can Our Governments Act Pre-emptively? That the operation of private markets can lead to environmental disaster is well established, both in theory and in fact. As well, the sub-prime mortgage crisis was plausibly the result of perverse incentive structures embedded deeply in progressively deregulated financial institutions when operating in real-time competitive conditions.1 For some, the sub-prime mortgage crisis should not have happened, even if the private financial institutions were working without serious regulatory oversight. But it did, and in retrospect, we can piece together why. The fundamental culprit is “moral hazard”—a misalignment of the costs and benefits of a decision and a related excessive focus on short-term results and no ability to enforce long-term accountability. The focus in this chapter and the next is on government as social decision maker. Can governments make corrections for the failure of private corporations, or households for that matter, operating in the context of a market capitalist society? Could the federal governments of the United States and Canada respond pre-emptively to the anticipated problems created by spiking energy prices and climate change? In principle, and in the confines of the university classroom, of course they can. Government policy-makers can make the necessary forecasts, rationally weigh the pros and cons of a prospective problem, decide on a course of action, select the appropriate policy instrument—whether tax, regulation, or spending—and implement the program. But can governments follow such prescriptions in practice?2 More important, can governments accomplish such a task when the crisis is not yet a reality, but simply a forecast, even if a highly plausible forecast? To answer this question, we must consider the design of our political institutions and the nature of the political market in which they operate. What governments can or cannot do in a democratic society is mediated by that marketplace. This chapter and the next set out some fundamental features of political competition within the constraints imposed by the constitutional design of democratic federal states. The essential features of the voting public are also considered.

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On balance, the argument here is that our political marketplace also fails us. As with private markets, the political marketplace is designed for short-term accountability, and its competitive features produce a form of moral hazard. As well, it has related pathologies that ultimately serve to undermine the public’s trust in government itself. As a result, our governments punt all really difficult choices into the future, not only hoping for the best, but eventually needing the best possible future circumstances. Our federal governments cannot act pre-emptively but only in response to “a clear and present danger.” In short, the calamity must be upon us before governments can respond in any material way. Then, of course, they can act with potentially an all-out mobilization of effort. At that point, unfortunately, no one can guarantee the outcome. Three examples of governmental response are considered in this chapter: the sub-prime mortgages crisis, oil depletion, and geopolitical energy security. Climate change is addressed in the next chapter.

The Political Marketplace Political Agency, Checks and Balances, and Short-Term Focus In the previous chapter, we noted that private corporations can suffer from what economists call an “agency problem,” whereby corporate executives (the agents) and even corporate boards may not act wholly in the long-term interests of the shareholders. Most modern democracies can suffer from exactly the same problem. They are, for the most part, “representative democracies” and not direct democracies. Elected officials are simply agents of the electorate. Their status as agents means that they may be no less inclined than their private corporate counterparts to serve their own interests, and not those of the persons they represent. There is always the possibility that, once elected, politicians will act opportunistically to pursue their own “hidden agendas,” whatever those might entail. In doing so, they may be predisposed to say one thing before an election, only to do another after. The problem for voters is to determine who is to be trusted and who is not. But “political agency” is far more complicated than that of their private corporate counterparts. Political agents not only must not act opportunistically on their own behalf, they must also represent the interests of all their constituents fairly and equally.3 This is more complicated than the situation facing the private corporate executive, because there is no single metric of “the public interest” that is comparable to “the bottom line” of the private corporation. That is, there is no common denominator in public life similar to profit expressed in dollar terms. So, in practice, impartial representation of all is an extremely demanding, if not impossible, requirement, except under very special circumstances.

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Democratic institutions are specifically designed to enforce the accountability of political agents to the voting public. Accordingly, all would-be political leaders must stand for election to office and face whatever political competition there is for that office. Typically there is not a long time between elections, so that voters reassert on a reasonably frequent basis the ultimate popular control of political leaders. There may even be term limits on elected office. The single most prominent such constraint is that the President of the United States is now limited to two, four-year terms. Other elected U.S. officials have no term limits but have varying terms of office between elections; senators serve for six-year terms and members of the House of Representatives for only two years. A staggered election cycle in the Senate, one-third of senators every two years and only one from each state at a time, is also designed to increase accountability. The Senate represents the equal regional power of each state in the Union, with two senators from every state regardless of population. The House of Representatives reflects more proportionately the population base of each state. The vote for the presidency reflects a combination of the two systems in an Electoral College so that small states are still somewhat disproportionately represented. Once in office, there are constraints—built-in institutional checks and balances—on the exercise of the power of political leaders. In the United States, legislative power is divided between the two legislative branches (the Senate and the House of Representatives) and the executive branch (the President and the Cabinet). Agreement from all three is required to make new law (although a presidential veto can be overridden by a two-thirds vote of each legislative chamber). While simple majorities are required for most legislation, current Senate practice effectively requires three-fifths (60 votes).4 The Constitution, interpreted by an independent Supreme Court, represents yet another constraint on the power of elected officials. The division of powers between federal and state governments, aside from the construction of the Senate outlined above, also represents a powerful regional constraint on the federal government. Although not required by the U.S. Constitution, the annual budget process is governed by legislation to increase transparency and therefore financial accountability. There are even unofficial constraints on political power implemented through the “Fifth Estate”—that is, in the daily news cycle in the private media. On balance, then, the political institutions of the United States are designed to reinforce short-term accountability. The election cycles, legislative checks and balances, the annual budget cycle, term limits, and the daily news cycle are all intended to constrain decisions to address immediate accountability. And there is virtually no accountability for results once an elected official has left office, except perhaps to those who write history. This design is fundamentally similar to other Western democracies.5

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Voters’ Rational Ignorance, the Tendency to Free Ride, and Self-Interest Before delving more fully into the nature of the competition between politicians, we should examine who is on the other side of this contract. What is the electorate like? This is important because it will also help to dictate the nature of the competition among politicians. As it turns out, the political market, where voters choose their representatives, is not like most other markets. Political debates about policy, no matter how much in the media or how vociferous, will not be engaged in by the general public. In fact, economists have long argued that voters in the political marketplace are “rationally ignorant.”6 To be sure, the public will have opinions, but not necessarily informed ones. There are simply too many issues to become well informed about them all. Moreover, it would be largely pointless. A representative democracy does not offer a smorgasbord of policies from which to choose. The electorate gets to vote only for a candidate, typically a member of a political party with a general set of policy positions. Additionally, a single vote is not material to the electoral success of any candidate. And even if a preferred candidate is elected, the structure of institutional checks and balances is such that no legislative platform, let alone any particular policy, is assured of becoming law. In short, there are so many constraints and contingent probabilities— resulting in a vanishingly tiny probability that a single vote can influence a specific policy outcome—as to make policy ignorance a rational voter choice. To repeat, this is not to say that many voters will not have opinions, typically based on deeply held beliefs, driven by emotional conviction. It is to say only that voters will not bother to have opinions fully informed by facts, logical reasoning, policy options and implications. The exception perhaps is when the voter has a large personal stake in a particular policy—for example a tariff, subsidy, tax benefit, or a spending program highly beneficial to them personally. The purposes of such private knowledge are not, however, to provide an independent assessment of collective or social costs and benefits. And this is exactly as one would expect. Good government is a public good in that all citizens enjoy it whether or not they participated in its creation. Therefore some potential voters opt out, content to “free ride” and let others decide for them. But even if one does not opt out, strenuous participation in public debate on behalf of the public interest is discouraged. The costs, including the enmity of opponents and perhaps those in power, are borne by the speaker or the active participant alone,7 but the benefits are widely shared. Those who do engage fully in politics typically are pursuing a private interest, however defined.8 Accordingly, politicians are most likely to be assailed by those seeking some private advantage, armed with facts and rationalizations, or by those harbouring strong emotional beliefs and preferences but who are ignorant of the facts and analysis of an issue. Outside

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these scenarios, politicians find themselves addressing people who do not really care to listen.

Voter Focus on Character While voters may be “rationally ignorant” with respect to policy, they do rationally focus on the character of would-be political leaders. The reason it is rational to do so is that personal character, or a person’s value system or fundamental belief system, is extremely important in his or her decisionmaking processes. Character, or what we assume to be character, matters. Evaluation of a politician’s character is as close as we are likely to get to being in the room with the decision maker who, when armed with all the information necessary, will actually make the decisions.9 In this way we do not have to know what future decisions politicians will be required to make, or even the information they would possess. Character, if it is of the kind we trust, presumably also reassures us that agents will restrain their self-serving impulses, even when we are not watching. As a result, the personal charisma of candidates, the public’s sense of their personal integrity and their personal beliefs, is vitally important. The fact that a political leader’s character matters so much to the electorate also explains why “character assassination” is such a prominent feature of political competition. Destroy a competitor’s character in the public mind, and it destroys the public’s trust in his or her agency. Such a candidate, no matter what other qualities the person has, can be quickly marginalized. Character assassination is abetted by the role of the media. The media are encouraged both to “muckrake” themselves and to report on the “muckraking” results of others. Such information, unlike detailed policy analysis, is understandable to the public and possibly relevant to their political decisions. Either way, it is frequently considered entertaining, even when shocking, and it sells. The good news is that the potential for muckraking and character assassination is likely to have a chilling effect on all those who might consider public office if they have ever engaged in any conduct that would not stand public scrutiny. The bad news is that it also has the effect of bringing discredit on all who would offer their services in this market. This tends to undermine the public’s trust in the entire “political class.” Every defect of character, it seems, is highlighted.

Money and Politics This mistrust is further accentuated by the fact that election to federal political office in the United States now requires access to large campaign budgets, in part to buy access to mass media—an essential instrument of modern political communications. In 2010, the average winner of a House seat spent $1,439,997 and the average loser spent $688,632. The average winner of a

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Senate seat spent $9,782,702 and the average loser spent $6,528,077. The most expensive Senate campaign cost over $50 million, while the most expensive House campaign was over $11 million.10 In the 2008 presidential election, then Senator Obama spent $730 million compared to $333 million for Senator McCain. In the 2012 campaign, the Center for Responsive Politics reports that President Obama’s campaign spent approximately $1.124 billion, while challenger Governor Romney’s campaign spent $1.290 billion.11 The clear possibility exists, therefore, that the agents of the people can become captured by specific financial interests. Politicians need financial support; otherwise, they consign themselves to a low probability of winning public office. Moreover, once in office, they tend to stay there if they choose. Incumbents typically win over 80 percent of elections.12 In short, money for campaigning is important to an agent’s chances of continuing success. As noted above, however, such private financial participation in public life is not done to pursue the public interest, assuming one could know what that is. It is done in pursuit of private interests. Accordingly, the dependence on large-scale campaign contributions also serves to undermine overall public trust in the fair representation of political leaders. Again, this serves to undermine the instrumentality of government in general.

The Political Market and Used Cars The political marketplace has some distinct similarities to the market for used cars. In that market, without regulation, the bad cars—the lemons—tend to drive out the good.13 This happens because the true quality of the used vehicle tends to be known only to its current owner. Buyers cannot easily determine the automobile’s quality prior to the sale. It could be a “lemon” that the owner is trying to unload. Accordingly, would-be consumers in this market apply a huge discount to every car they would buy, without discrimination. The owners of good cars, therefore, cannot get their true value; so they exit the market, leaving only the bad cars. In a sense they are driven out by the willful dishonesty of their competitors.14 The same type of “asymmetric information” problem can apply in the market for the decision-making services of a “political agent.” Political hopefuls might well be concealing a “hidden agenda”—their intention to act opportunistically in their own interests or to break their commitments once in office.15 Only the candidates themselves know their true motives. How then are voters to know whom to trust? Many voters respond to this conundrum by assuming that all politicians are opportunists by nature. They will do and say whatever is necessary only to get elected. Such an attitude, of course, imperils the entire political marketplace. Potential voters may turn away from politics or stay silent if they do not support the actions of their government. In this instance, trust in government collapses.

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Accordingly, candidates must contend with the problem of how to signal their true quality as persons who will tell the truth, who will keep their promises, and who will not act differently behind closed doors than they do in full public view. They must convince us that they will not say one thing before an election and do something entirely different once in office.

Political Branding Brand names are one device by which private markets overcome the problem of keeping one’s promise after a contract has been made. The brand, created in part by heavy advertising expenditures, is essentially a promise of the same quality service, every time the service is utilized by a customer. Franchising is another illustration of the same technique. There will be no cheating. Political branding has a similar intent. It is a signal, and indeed a promise—one could call it a contract—that all problems will be addressed within a predetermined set of moral or ethical principles by the agent elected under that brand. A political “brand” is, of course, just another word for a political “ideology.” The problem is that this type of marketing tends to divide the electorate into groups that always vote for their “brand.” This in turn has the potential of making consensus decision-making extremely difficult to achieve. The more evenly divided the voting support for the competing brands, the less likely a consensus solution can be achieved. While branding solves one problem, it can create another by undermining the operational capability of democratic governments to decide and thence to act. It can produce paralysis, especially in the context of a complex system of institutional checks and balances. A political agent must not self-deal, must tell the truth, must not renege on promises, and must represent all constituents impartially. But strong political brands mean that strongly identified “brand” politicians do not, indeed cannot, represent everyone equally. They cannot, because they do not see the world in the same way as those who voted for a competing brand. And, of course, as was outlined in an earlier chapter, there are profound and perhaps irresolvable philosophical differences embedded deep within market capitalism. Therefore what begins as an answer to one problem in the political marketplace may beget a more profound problem that, in the extreme, undermines the legitimacy of representative government itself. Of course, many voters do not subscribe to a political brand. Indeed, in the United States there has been a long-trend increase in the number of voters who refer to themselves as Independents.16 These voters may be the most important group since they can potentially swing the overall vote one way or another. Accordingly, they are typically the object of the concerted attempts by politicians to persuade and to win their votes. This leads directly to another and, in some ways deeper, problem of the political marketplace—

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just as in the market for used cars, the “bad” competitors can drive out, or at least mute, the “good.”

Political Competition and Misinformation In the political marketplace, talk is cheap. There are no objective standards of fact or reason required.17 As in the market for used cars, everyone just makes their best case. It is also more like a courtroom than a science laboratory. But it is not like giving evidence in a courtroom. No one tells the whole truth and nothing but the truth. No one is sworn to do so, and no one does so. Everyone uses selective facts at best and outright misinformation at worst. Logic rarely matters. The purpose of political dialogue or debate is crass persuasion, not rigorous understanding of physical or social reality. There is no independent regulator of political speech. The whole truth is rarely spoken by any one candidate. No single person gets enough air time to speak the truth, even if they wanted to, because the truth is probably too complex and nuanced. And, remember, the public has no incentive to do its own independent fact and reason check on what is being offered. In any case, the public’s attention span, if it is paying attention at all, is extremely short, frequently measured in 60-second sound bites. Thanks largely to the work of psychologists, it is now widely recognized that our individual perception of reality and our individual decision faculties fall well short of that required for perfect rationality, especially when confronted with risk and uncertainty. Humans often have conflicting priorities, as well as being subject to all manner of emotional responses. Using our rational faculties is difficult and energy consuming. It is far easier and quicker to respond with an instant or “gut” reaction.18 Accordingly, all political messages are carefully crafted and “pre-packaged,” using the techniques of mass marketing and communications theory. Key words and phrases or images are all that is necessary or possible. These communications techniques in turn are constructed using science-based insights into human psychology and human decision-making—the same insights that underpin modern behavioural economics.19 For participants, the realities of the political market are no less concrete than the reality of the physical world revealed by the physical sciences. But at its most extreme, the only reality in the political market is expressed by what people can be brought to believe.20 Everything outside that reality is a mere technical detail. In this context, it is impossible for the general public to decide objectively who is right, even if citizens were so inclined to rigorously evaluate the evidence. Mark Twain’s dictum on newspapers also applies to political speech. Twain reportedly said, “Those who do not read newspapers are uniformed. Those who do are misinformed.” So it is in politics.

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Just as in the market for used cars, competition is not a self-correcting device in this context. In fact it potentially makes matters worse. In one sense, every politician is behaving opportunistically with respect to the Independent voters—as long as candidates’ messages do not stray too far from their political brand. Each side of the ideological divide believes that the other is deliberately misrepresenting reality in some crucial fashion— because, of course, almost inevitably they are. In this competitive context, the “truth” about risks or potential future problems and the advisability of accepting the current costs of insurance against such risks can easily be a victim. Even if political leaders personally believe there could be grave long-run risks to a current course of action, they may be disinclined to propose appropriate course corrections if it would mean immediate costs imposed on the electorate. They may choose simply to avoid the issue or be mute. Or they may propose elaborate long-term visions with little in the way of short-term substance. The reason is political competition. Competition locks political leaders into the societal gamble, because their political competitors are always willing to argue that such risks are bogus and the costs unnecessary. Why should the political opponents not behave opportunistically in this way? The object is to win office, and there is no official penalty for being illogical or factually incorrect in one’s statements. There is also no official independent verification of fact and reason in respect of any policies. There are simply competing opinions. The only real penalty is losing an election—the equivalent to losing market share in the private sector. There is no long-term accountability to speak only the truth about the present, let alone future possibilities. In short, imprudent actions with high levels of immediate benefit, or at least avoidance of pain, can drive out more prudent policies, just as it did with Wall Street tycoons in the sub-prime crisis. In politics, as in used cars or currencies, the “bad” can indeed drive out, or at least mute, the “good.”

The Cumulative Effects on Public Trust In summary, the nature of political competition—everything from character assassination to branding to rhetoric that is often devoid of fact or reason— helps to undermine public trust in the agency of government itself. And this shows up in public opinion polls. The decline in public trust in government is vividly illustrated for the United States in Figure 5.1, covering most of the post-WWII period starting in the Eisenhower administration. To be sure, the interaction with economic performance can be witnessed in the partial recovery of trust during the Reagan and Clinton administrations. But the decline in trust begins in the 1960s, before the sharp decline in economic

How much of the time do you trust the government in Washington? Trust

Just about always / most of the time

Distrust

Some of the time / never

Trust by Party

Just about always / most of the time

  EISENHOWER  KENNEDY  JOHNSON  NIXON  FORD  CARTER 

REAGAN 

BUSH 

CLINTON 

BUSH 

OBAMA 

Distrust

80% 73%

Trust

73%

60

Compare trust in government to: Satisfaction

Satisfied with the state of the nation

Confidence

Consumer sentiment

Unemployment

Monthly rate

Incumbent Losses

Number of House incumbents defeated

40

26%

23%

20

0 Key Events 1960 

1970 

1980 

1990 

2000 

2010

Source: Pew Research Center, National Election Studies, Gallup, ABC/Washington Post, CBS/New York Times, and CNN Polls. From 1976 to 2010 the trend line represents a three-survey moving average. http://www.people-press.org/2013/01/31/trust-in-government-interactive/.

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Figure 5.1 Public Trust in Government: 1958–2013

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performance that started in 1973, and indicates a general trend that reflects the sentiments of Independents as well as Democrats and Republicans. Low public trust in would-be political leaders translates into a diminished power of government to lead. Leading implies not only going first and bringing others along, but also making decisions for the group. These decisions almost inevitably rely on forecasts. Yet, in the political arena, forecasts are not facts, no matter what science went into the forecast. On the other hand, no one can deny that the entire public will respond vigorously to a clear and present danger—such as being attacked by an enemy or having imported energy supplies embargoed and actual energy price increases. In this instance, a political leader does not have to prove that a problem will exist; it is already evident to everyone, expert or not. Political leaders simply have to get in front of a parade already forming to demand action. The simple lesson is that potential calamities will be dealt with when they happen, and not before. We push all socially difficult choices into the future, not only hoping for the best but needing the best possible outcome. This response is illustrated in the way governments dealt with the sub-prime mortgage crisis.

Risk and the Punch-Bowl Problem: Sub-prime Mortgages Again We have already reviewed how some perfectly rational private financial institutions might well “bet the farm,” even in the face of existential risk. As to the public sector response in that context, we can turn again to former Federal Reserve chairman Alan Greenspan, the ultimate Washington insider. “I am also increasingly persuaded that governments and central banks could not have importantly altered the boom either,” Greenspan writes. “To do so, they would have had to induce a degree of economic contraction sufficient to nip the budding euphoria. I have seen no evidence, however, that electorates in modern democratic societies would tolerate such severity in macroeconomic policy to combat a prospective problem that might not even materialize” (523; italics added). Many people were benefiting from the expansionary phase of the housing bubble and not just bankers and real estate agents, but also the countless millions of homeowners in many countries who were experiencing rapidly rising home equity values. The economy had low unemployment and low consumer price inflation and all homeowners were experiencing increases in their personal net worth or were enjoying a consumption spending spree financed by increasing their mortgages. Cars and boats and home appliances were all selling well. Everyone was benefiting. Woe to the government(s) that would take the punch bowl away from that party! The Federal Reserve in this instance was not confronted with a rising general inflation, which it may well have been able to nip in the bud. After

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all, Paul Volker supported by President Reagan had done it successfully in the early 1980s, at great economic cost. But the rampant inflation of the late 1970s had been a clear and persistent reality. Just prior to 2008, however, the Federal Reserve was confronted with a hypothetical future financial calamity. Admittedly, some experts were predicting it, but the majority consensus was that it would not happen—that this time was different from previous financial bubbles. Moreover, the asset bubble had no current victims and many current beneficiaries. Yet catastrophe very nearly came to pass … and might still. Some will dismiss Alan Greenspan as writing merely to defend his reputation. Perhaps he is; who would not be so inclined? But Greenspan is also a hugely experienced, knowledgeable, and politically perceptive operative, and a long-time holder of the key financial job in the United States. It seems equally probable that his views reflect how institutions—both public and private—actually work when confronted with risks, even risks that could threaten their very existence. It is also possible to argue that central bankers in general, the would-be financial regulators, are simply the captives of those they are supposed to regulate. They turned a blind eye as the housing bubble inflated, and they went to truly unconventional and extraordinary measures to bail out the key financial players after the bubble burst. That may well be a fair assessment of the situation. If true, however, it serves only to undermine the notion that independent, pre-emptive policy action is possible to deal with crises before they happen. Few institutions in a democracy are afforded so much independence from politics, or are governed by so much “rational thought.” If the “Fed” cannot act with rational foresight, but only energetically “bailout” after the catastrophe has happened, then there is little hope that any democratically elected body could do so.

No Innocents at the Party In the wake of a crisis, people naturally want, perhaps need, to assign blame. In the case of the sub-prime lending crisis, where that blame belongs seems perfectly clear—Wall Street and its regulators and their equivalents throughout the Western world. Indeed, if our foresight were as good as our hindsight, nothing would ever go awry again. We believe we know who is greedy and who is not, and who is complicit and who is not. In truth, however, there are typically no innocents at the party. The modest-income individual who buys a palatial home or maybe two, expecting real estate prices to continue to climb, is intrinsically no less greedy than the financial mogul who facilitates the transaction. Nor are governments innocent. After all, home ownership was explicitly encouraged by government policy and supported by all political parties. Widespread home ownership was believed to stabilize society, not destabilize it. Everyone is enjoying the party—some more than others undoubtedly. But everyone is up and dancing!

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What if everyone who is on a winning streak, or hopes to get in on the game, is at fault? When things are going well, it is extremely difficult to stop the party simply because something might go wrong in the future. Call it the “tyranny of the present”21 if you want. But it is a powerful political reality, especially because it afflicts so many of the partygoers. In short, our governments do not exist independently of the social milieu in which they operate—as Alan Greenspan observes. We may imagine governments as independent actors, ever watchful for impending disaster and capable of acting rationally in anticipation, but this does not mean that they actually are independent, watchful, or capable of rational pre-emptive action. Governments do not respond to forecasts, they respond to “clear and present danger.” Indeed, our democratically elected politicians for the most part cannot do otherwise.

Oil Depletion: What Would Happen If Governments Did Try to Act Pre-emptively? The argument in this book is that the depletion of global oil resources is not likely to show up as a relentless and continuous increase in the real price of oil. That is not how the industry works. It is far more likely to show up as a discontinuous and erratic spiking of oil prices followed by a sharp retreat. Each time, however, there will be macroeconomic dislocation. Moreover, both the probability of a macroeconomic impact and the impact itself is growing because of the increase in income inequality in society. As the poor and near poor in Western society become more indebted, the potential to set off a downward spiral as a result of spiking oil prices increases. The ultimate impact also increases because of the presence of so much more leverage, so much more debt in society. Research shows that recovery from recessions that occur in the presence of excessive debt is always slower and unemployment more prolonged.22 A prudent government has a couple of options to respond to this potential: act to wean the nation off oil, and spend heavily on research and development.

An Off Oil Policy Suppose a president whose own party had control of both the Senate and the House of Representatives in the United States becomes convinced to enact legislation to reduce the U.S. dependence on oil. The interim target could be to reduce oil consumption by say 5 to 6 million barrels per day by 2025—roughly the amount of imported oil from non-North American sources.23 So, incidentally, this same policy would provide a high degree of energy security. The technical question becomes how best to accomplish that action. Impose an oil tax? Prohibit imports of non-North American oil?

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In truth, it is not likely to matter what legislators choose. The result will always be to raise dramatically the domestic price of oil—the very thing that the government is purportedly concerned about!24 The government would be raising the price of oil now, so that it could avoid some future hypothetical increase in the price of oil. The political reality is that a very large swath of the electorate would not understand the point of such a policy. The key is that it would require a vast and painful transformation of the lifestyle of most households in the present. Such an action would not be in accord with how people run their own lives, even if they believed the forecast. Many, perhaps most, would not believe the forecast. Moreover, even if the government promised to recycle the revenues from the oil tax back into the economy, many would not trust the government to do so in a manner that would not redistribute income in some way. In short, pain in the present in order to avoid a hypothetical future recession would be a difficult political sell, as Alan Greenspan pointed out in respect of the sub-prime mortgage crisis. His option to address the housing bubble before it burst was to raise interest rates or to regulate the provision of sub-prime mortgages more closely to restrict their availability. As he explained, neither option would have been politically palatable. There is an extremely important divide in the electorate—between the top 10 percent of income earners and all the rest. The vast majority of households have seen little or no improvement in their real incomes over a prolonged period, for reasons outlined earlier. They are burdened by debt, have little or no savings, and are extremely vulnerable to any adverse contingency. These households cannot afford to give up current income in order to invest or take out insurance against some future adversity. Aside from vastly different financial circumstances, the political divide may also reflect a difference more deeply embedded in the psychological makeup of different groups of voters. Some people may be disinclined by nature, or at least by training, to forego current consumption in return for some future benefit, or to avert some future cost that may or may not occur. What would prevent the political opposition from exploiting this situation, even if confidentially they agreed that “off oil” was a prudent policy? It is almost guaranteed that some politicians would seize the opportunity to champion the opposition to the policy. And this does not invoke the inevitable objections of those domestic oil interests involved in the transporting, refining, and marketing of imported oil. Given the construction of the Senate, this opposition would not be a trivial matter. We investigate this issue more fully in the next chapter in respect of climate change. On the other hand, if the government does nothing and the forecast of peak oil turns out to be correct, then oil prices will rise on their own. The government can respond to the negative macroeconomic effects of the price rise, as well as pass regulations to reduce energy consumption in line with the strong price-incentive effects that voters already will be experiencing.

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In short, whether oil prices are spiking because of rising demand pressing on an inelastic supply, or from geopolitically inspired disruptions in supply, they induce large-scale macroeconomic effects. As noted above, this impact is heightened in the presence of high debt levels. Even so, the near inevitability of future energy price spikes and their negative macroeconomic effects are not material to our actual energy policy. Their effects on output and employment will be dealt with when they occur. There has been no credible and sustained government attempt to get “off oil” or achieve oil geopolitical security by reducing its consumption since the first OPECinspired price spike in 1973. Our governments must wait for the economic crisis to happen. Even Keynesian economics was never meant to forestall a depression, only to respond to the reality of its occurrence. But that is not the only complication. A highly insured society must also be a heavily regulated society if it is to minimize moral hazard. While the Keynesians expect government to come to the rescue once the party crashes, others, specifically neoconservative policy advisors, insist that the “dead hand” of government regulation not extinguish the economy’s animal spirits before the party even really begins. Alan Greenspan’s mistrust of regulation was not just a personal whim. It is deeply embedded in our political ideology. What is a government to do? The answer is obvious: do both. Lay off regulation and taxes on the way up and bail out and otherwise pump up on the way down. Everything is sacrificed to economic growth. The result is to invite risk-taking without any possibility of restraint.

Government Research and Development As noted in the previous chapter, we must acknowledge that private markets fail to provide funding for basic scientific research, including new energy technologies. This would seem to suggest that governments could have an especially important role in funding energy research and development (R&D) in anticipation of future energy-related mega-risks. Governments, particularly for purposes of national defence, have been the originating source of many modern inventions, subsequently commercialized by the private sector—for example, the Internet, the GPS, the jet engine, and nuclear power. A concern for energy security should be revealed by research spending on new energy-related technologies.25 In fact, when oil prices spiked in the 1970s, the government did respond by increasing investment in research, development, and demonstration (RD&D). But that is not the point. The allocation of government spending to future energy technologies shows a tendency to follow actual “energy crises,” not anticipated future problems. For example, in the United States, “during the late 1970s the government invested more than $7 billion per year (2005$) in energy RD&D. From the 1980s through the mid-2000s federal investment

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hovered around $3 billion annually. Since then, federal energy RD&D has increased slowly, excluding the one-time jump in stimulus funding.”26 As soon as the crisis of higher oil prices was seen to pass, government research efforts shrank. In short, actual government spending on energy research and development responds not to anticipated future problems, but to actual and immediate problems, not unlike the private sector response. Even at $7 billion per year, this expenditure is minuscule compared to a defence budget of over $706 billion in 2011 (not including more than $127 billion in veteran benefits and services for the same year). Recent wars and related security spending since 9/11 cost the U.S. government alone $886 billion for Iraq and $444 billion for Afghanistan with another $36 billion in enhanced security and other unallocated expenditures.27 Would not a prudent society, with an annual GDP in excess of $15 trillion and federal government expenditures in excess of $3.6 trillion in 2011, spend vastly more on energy research and development? In summary, the U.S. government spends a minuscule amount on civilian energy-related research and development compared to current and capital expenditure on military preparedness against attack. To make matters worse, in the context of immediate government budgetary constraints, civilian energy research and development might easily be a casualty. It has an uncertain payoff, and it has by comparison to military spending, or Medicare spending with its large medical establishment supporting it, a very small constituency. The lobby that represents the enormous fossil fuel industry, of course, would have very little interest in government expenditures on alternative energies, except perhaps to discourage them. The very rich tax incentives for private research and development would go principally to those who would expand the existing fossil energy industry.

Energy Security and Military Spending So is an enormous military budget an example of a government acting prudently? Military spending in peacetime, well in advance of a potentially adverse event and without specifying the precise nature of the threat, might be thought of as an insurance policy as well as a deterrent to a potential aggressor. Many on the political left, of course, believe it is an instance of excessive prudence, the expenditure far exceeding their personal estimate of the risk of loss from external attack. Yet the military-industrial complex in the United States is an outcome of a war that did indeed involve an initial surprise attack on Pearl Harbor. The subsequent Cold War military build-up was also the result of an unresolved and prolonged conflict of ideologies between nuclear-armed states. And the most recent escalation in U.S. military-security spending reflected yet another psychological jolt from the terrorist assault of 9/11 on Washington and New York City. Current opinion polls in the United States indicate that

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over 50 percent of Americans believe that a city in the United States will experience a nuclear attack before 2050.28 So does U.S. military spending and other related security spending reflect “prudent behaviour”? Or is it a real-time response to what is perceived as an almost continuous clear and present danger? It may not be possible to know for sure. Military spending in times of relative peace creates good jobs and opportunity for advancement by many. It is widely distributed across the nation. It is possible that such spending has acquired a politically unassailable position, as President Eisenhower once warned against. But a peacetime military expense is far different from actual preemptive war. Consider specifically the pre-emptive war launched by President George W. Bush against Iraq in 2003. Was it an example of a pre-emptive energy policy action aimed at enhancing energy security? Alan Greenspan believed the invasion of Iraq was about oil, and that may well have been the case. A successful war with Iraq could have provided more military bases for U.S. forces in the Persian Gulf as well as opened the world’s third-largest reserve of conventional oil to development by Western-owned oil companies. But that is not how the action was framed for the American public, or the world. And the political justification is what matters to the argument here. The Iraq war was presented to the American public as a necessary military response to a clear and present danger. Saddam Hussein and his regime were identified as an enemy intent on attacking the United States and its allies with weapons of mass destruction. To be sure, supporters of the war had other justifications. For example, it would remove an evil dictator capable of mass murder; it would bring democracy to Iraq, which could then be an example to others in the Middle East. But it was the “clear and present danger” to Americans that was central to the political case for immediate action. The case for a clear and present danger was made far more credible because Islamic terrorists had in fact already launched an unbelievably successful attack on 11 September 2001. Moreover, Saddam Hussein had once possessed chemical weapons and had used them on the Kurds. At one time, he also had a nuclear weapons program. That ultimately no evidence could be found that Iraq possessed such weapons, or of Saddam Hussein’s links to Islamic terrorists, does not change the prior allegations. It simply means they were not true. What was important was the ability to persuade an already predisposed and frightened public. In addition, some officials in the Bush administration suggested that the war would not be costly to the United States, since it could be financed from sales of Iraqi oil once the dictator was dispatched. Moreover, a minimalist invasion force was assembled. This, too, would save money and minimize disruption to the lives of members of the American military and their families. The Iraq war was not supposed to involve great sacrifice of American lives or treasure.

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Of course, this estimate of cost also proved to be inaccurate. While it was a force size that easily succeeded in the invasion, it failed to be sufficient “boots on the ground” to bring peace once the invasion was completed. As a result of this and other miscalculations related to disbanding the Iraqi army and rooting out Baathist party members from the public service, the ultimate cost in lives and money was far higher than anticipated. Nonetheless, the fact remains that the political case that persuaded the American public, the Congress, and significant elements in the media was of a low-cost, pre-emptive military action to eliminate an immediate and dire threat. In the context of 9/11, many people of all political persuasions accepted this case for immediate action.29 Without making the case for that dire threat, the President would never have been given political license to pursue the war.

Conclusions The political marketplace, wherein we choose our would-be governmental leaders, suffers from some inherent defects in its operation. The voting public is opinionated but uniformed, and there is little incentive to become informed. As a substitute, some look to the character of politicians. But character assassination is now a common feature of political competition. This has served merely to undermine trust in the entire political class. And growing resort to communications battles financed by massive amounts of private money has undermined even further the public trust in government as an impartial arbiter. Branding, which in other markets helps to overcome the problem of opportunistic behaviour, when pursued in the political marketplace simply deepens the ideological divide in society and makes it even harder for government to act, especially in the context of a system designed with powerful built-in checks and balances. Political competition not only does not resolve these problems, it accentuates them. Perhaps everyone means well. But they may also tell themselves that they cannot do “good” if they do not win. Among political competitors, selfserving opportunism and a careless disregard of fact and reason override good intentions. The purpose of political speech is to persuade, not tease out scientific truth. Who is to catch them out? There is no official and independent supply of fact and reason agreed to by all the major parties. And the voting public has no incentive to invest its own time. In this context, political competition is not constrained by any inconvenient truth, on any subject. Political competitors are particularly encouraged to avoid policies that inflict short-term pain for long-term gain. Their entire focus is on winning the next election, which is almost always looming on the immediate horizon. Some competitor is always willing to decry the need to pay for insurance of any kind against some future possible problem. There are no other

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consequences of this short-term focus, only the immediate one of winning or losing an election. We want social insurance on the one hand and do not want to be heavily regulated on the other. We want to keep on partying. So our political leaders do both, deregulate and offer bailout insurance. In this way, politicians are driven by competition to allow social risk to accumulate, just as Wall Street bankers are driven by competition and shortterm profitability to allow their risk to accumulate. This tendency is further abetted by an electorate that is often unwilling, and increasingly unable, to make short-term sacrifices for long-term gain. The future does not get a vote. Democratic governments cannot respond to forecasts of crisis, but only to threats that have become widely recognized as “a clear and present danger.” This is not an entirely new phenomenon in democracies. Even our greatest leaders have had to bide their time. Winston Churchill found no large-scale public audience for his perspectives on the threat of Nazi Germany until the reality of the invasion of Poland. President Roosevelt in 1941 saw clearly the geopolitical threats of Nazi Germany and Imperial Japan. But he could not respond with overwhelming force until Pearl Harbor and the German declaration of war made those threats a defining reality for the vast majority of Americans. President George W. Bush could not have invaded Iraq and Afghanistan without the terrible tragedy and jolt to the American psyche that 9/11 represented. The bailout of U.S. financial institutions under Presidents Bush and Obama could not have happened without both the rhetoric of impending general economic disaster on the scale of the Great Depression and the reality of some failed financial institutions in the United States and Europe. This is not to deny that using a crisis to justify government action can itself carry grave danger to good public policy and indeed to liberty itself. For example, a large segment of the formerly approving public is now disillusioned with the results of recent wars and economic bailouts. But that does not change the argument here. For better or worse, governments can respond to crises because, at the very least, these events appear to be concrete and compelling realities to an otherwise philosophically deeply divided and deeply mistrustful electorate. Almost everyone can then agree on the need for response. Of course, being able to act only in the context of a crisis cannot be labelled prudent. But it is especially imprudent if one proceeds to experience the future in a highly vulnerable state. As economic growth continues to slow in Western economies, even while others in Asia and South America catch up economically, the pressure on our governments to get the party going and keep it going will become far more intense. This pressure for growth will be augmented by the enormous overhanging debt burdens of all governments that provided the bailouts and countercyclical fiscal response to the initial sub-prime debt debacle. Economic growth— a rising tide that lifts all boats and resolves all problems—is perhaps the only politically palatable way out from under this debt burden. Otherwise

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governments will have to decide, quite explicitly, who will pay. Our political institutions are not well designed to address such issues. All difficult social choices, including environmental ones, are pushed into the future. Climate change, to which we now turn, illustrates the problem perfectly.

Chapter Six

Can Our Governments Forestall Climate Change? Climate change stands out as the ultimate problem of public policy. Unlike resource depletion, no one suggests that our private corporations are designed to deal with such a problem. If any institution has a chance to come to grips with this issue, then it is surely our national governments. But even national governments are not enough. Since global warming is made worse by carbon emissions anywhere in the world, or the destruction of forests anywhere, it must be met with a global policy solution. There can be no “free-riders” among the big national economies. Otherwise, restrictions on the use of fossil fuels in North America and Europe, but not Asia or anywhere else, would simply hasten the shift of energy-intensive industry to developing nations, with no global climate benefit. Indeed, given Asia’s dependence on coal, global emissions would be made worse. Accordingly, all, or at least most, governments must adopt a corresponding policy to limit carbon emissions. Needless to say, this requires comprehensive global intergovernmental coordination and agreement. As in the previous chapter, our question is: Are the federal governments of the United States and Canada capable of rational pre-emptive action with respect to climate change? Can they take comprehensive action—including entering into necessary international agreements—to forestall serious climate change? Or must we wait until there is a clear and present danger and simply react to the effects of climate change? Again, to answer these questions requires an understanding of what that pre-emptive action would necessarily entail, and how the design of our political institutions dictates their likely response.

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Carbon Emission Reduction: Impact on Economic Growth and Income Distribution There is widespread agreement among experts, certainly among economists, on the single most effective policy instrument that is available to deal with climate change—a carbon tax, applied as an excise tax on the carbon content of each fossil fuel.1 A carbon tax is not the only instrument available or the only one that would be useful to employ. A regulation capping total emissions at some level and then issuing tradable emission permits—so-called cap and trade—can approximate the carbon tax. Other types of regulation on building and appliance energy-efficiency standards can help. With respect to the destruction of forests, the solution is to make an incentive payment equal to the equivalent annual value of carbon sequestered by living trees. This would presumably remove the incentive to destroy these forests for the sake of growing other crops with only marginal returns. A carbon tax, rising relentlessly but gradually over time, would affect every private decision as well as stimulate every conceivable form of technological change to reduce carbon emissions.2 Such a tax would promote carbon sequestration initiatives and reduce fossil fuel use through greater energy efficiency, as well as encourage renewable energy development. Of course, a carbon tax, even though rising gradually through time, could have adverse macroeconomic effects typical of large energy price increases. Low-income groups—spending a considerably higher portion of their income on food and direct energy consumption—would be the most adversely affected. To offset these negative effects, the revenues from the tax could be recycled to sustain overall consumption by low-income households. As noted earlier, the precise impacts of a carbon tax on long-term economic growth are still a matter of expert debate. Their estimates vary depending on the availability, cost, and potential speed of introduction of new technologies to save energy, capture and sequester carbon, or substitute low carbon alternatives to fossil energy. All that can be said for certain is that there is some cost. It could be modest if the new technologies can be deployed at reasonable expense (especially carbon capture and sequestration in relation to coal use).3 It is also the case that it is better to start sooner rather than later, and to have a steady and predictable ramp-up in the tax. What is not subject to debate, however, is that such a policy implies a huge redistribution of income away from fossil fuel owners, producers, workers, and regions. The incomes and ultimately the populations of fossil energy rich nations and regions would slow and even decline as demand for energy in general is constrained and as demand is shifted to the new, low carbon alternative fuel sources. The primary purpose of the carbon tax is not to raise revenue, but to engineer a vast industrial and social transformation away from dependence on fossil fuels. The revenues from a carbon tax could, of course, be used to compensate the income losers in the fossil fuel industries. But the revenues from the tax cannot be used twice—to compensate both

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the poor and the fossil fuel owners. Accordingly, some politically satisfactory mutual split would have to be found. Once again, the question is whether our political institutions are actually capable of implementing such a policy-induced transformation and, even more importantly, the associated massive income redistribution it implies. It is one thing to tolerate technological change that makes one’s job redundant or one’s assets worthless. Some might take it as simply the luck of the draw or the capricious nature of capitalism’s “creative destruction” at work. It is quite another thing, however, to have such an outcome imposed by policy made in Washington or Ottawa, whatever its motivation. As already noted, any cost to economic growth would gain little political acceptance, especially now in 2013. Moreover, there is no clear and present danger from global warming that is readily manifest to the average voter. It is still a forecast in terms of imposing deep costs on the vast bulk of North Americans, or indeed on most of humanity. But this is not the only constraint on government action. There are other very important constraints that militate against a significant pre-emptive policy response led by the federal governments of the United States and Canada, including the basic design of our political institutions. We outline several such constraints below.

Tyranny of the Present: The Politicians Political leadership, when not hemmed in by political ideology or branding, is hemmed in by the design features of our political institutions—the annual budget cycle, the election cycle, and the typically short tenure of even the most successful prime ministers or (constitutionally limited) presidents. As noted earlier, these design features demand almost immediate accountability and sharply constrain independent action by our political leaders. In the United States, the institutional design of checks and balances between the executive and the two legislative branches makes leadership without mass consensus even more difficult than in Canada’s parliamentary democracy—at least in the short term. While a president is constitutionally limited to two terms of four years each, in actual fact the president has, at best, the first two years in each term, should they get two, to take really defining policy initiatives. After that, they must be concerned about mid-term elections in Congress, in order to maintain their partisan legislative support. But what if the problems confronting society do not fit into this short time frame? The consequences of some decisions will not be discernible for 20, 30, or more years. As noted in the previous chapter, given the structure of our political institutions, there is a strong incentive for political leaders to avoid imposing immediate costs on society, but to make ambitious long-term promises. There is no accountability for these promises, except perhaps to history, once our political leaders have left office.

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Politicians therefore have a constant incentive to punt all really difficult decisions into the laps of some future politicians.4 Being strong on visionary statements but short on immediate substantive effort is not unusual in politics. Political competition, just as in the case of corporate leaders, does not correct for this incentive. It makes it worse. If the public does not wish to make current sacrifices, or does not see itself as being able to afford them, then some would-be political leader will promise that those sacrifices will not be necessary. There is no consequence for being wrong. Winning is all that matters in this competition, as in others.

Branding Constraints But political opportunism is not the only problem. We each of us imagine that if we foresee an issue not addressed by our governments, then it must be a failure of political leadership. And indeed our political leaders, presidents or prime ministers, do have great power.5 But can a charismatic leader, having won, proceed to move immediately in unpopular directions? As purely opportunistic as some politicians can seem, they do not have nearly as much room to manoeuvre as we might imagine. As noted, most leaders emerge within the context of a political party and hence a political brand. They must be chosen first by that party. In short, they owe their opportunity to lead to those who constitute the party. The party’s political brand is designed to, and does, limit the potential opportunistic actions of those leaders. To act outside the brand is to forsake one’s political base and violate its trust. We may often wish leaders, once elected, to act with “political courage” and disappoint their “base”; but when it does happen it serves only to reinforce the mistrust in politicians and leads inevitably to attempts by their political base to regulate their future behaviour even more tightly. In the longer term, this further limits the instrumentality of government. Within the United States, views on global warming differ significantly depending on one’s party affiliation. A Pew Research Center poll released in December 2011 found that only 19 percent of Republicans believe that the earth is warming because of human activity.6 The number was 51 percent for Democrats and 40 percent for Independents. Given this underlying belief structure, it is difficult to imagine most Republican politicians being able to take any leadership role on the issue.

Tyranny of the Present: The Electorate The constraint imposed on politicians in respect of climate change is not just willfulness on the part of some voters of a particular ideological brand. In fact, there is a far more broadly based constraint. As noted earlier, the energy price spikes of the 1970s and early 1980s have left a lasting legacy.

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They accelerated the global structural shift of manufacturing employment out of the developed Western economies to the Asia-Pacific economies. One of the key results of this shift in the United States, and even in Canada, has been a steady increase in income inequality. Incomes for most have stagnated or declined in real terms. It is now much more difficult to achieve a middle-class lifestyle, especially for those with or without a high school education. Even a university or college education is no longer a guarantee. As a result, more households are living fully exposed to the vagaries of life—whether illness, job loss, accident, divorce, or crime. We accept that our political leaders have short time horizons. But we often fail to appreciate that this is largely because a substantial part of the general public, of all political persuasions, has even shorter time horizons. Many people live paycheque to paycheque, preoccupied with the daily and weekly problems of feeding, clothing, and housing themselves and their children. Intellectuals debate the appropriate social discount rate to be applied to forecasts of future costs and benefits over several generations. But the concern for future generations of grandchildren or great grandchildren is to some considerable extent a luxury for the relatively wealthy, and for the political, social, and academic elite who can save. The rich and the poor, or near poor, may live in the same city, but they are from different planets when it comes to their thoughts and their ability to act in respect of the future. Many individuals do not, indeed increasing numbers cannot, save enough money even for their own future retirement. This fact is notwithstanding that they have certain knowledge that they will age, if not grow old. What chance is there, then, that these same households can make provisions for future generations to deal with matters that can only be stated in terms of probabilities? And how different is this from the poor farmer in the classic Malthusian trap? Not much. In the United States over 100 million people live in poverty or have after-tax incomes within 50 percent of the poverty cut-off. It does not take much of an adverse shock—divorce, sickness, job loss, unplanned pregnancy, or energy price spike—to profoundly alter their economic circumstances for the worse. They are trapped by their circumstances; potentially, so is the nation. The economic plight of the poor and near poor imposes very important limitations on what democratic governments can do in response to long-term social risks such as climate change.

Perception Problems As we noted previously, most voters are rationally ignorant. While not fully informed on the options available, they will, however, judge the results of any policy. In this sense, they apply a “taste test” more than anything else. For example, voters may not understand how electricity is generated or is

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distributed to their homes. But they do immediately react if the lights go out or their monthly bill seems disproportionately high. Unfortunately, climate change is a problem that does not fit well with this institutional reality. The cost of dealing with climate change, expressed as a tax, will be felt immediately in every household budget. But the benefit is not only delayed, it cannot be directly experienced. Even if a major global initiative to reduce carbon emissions were undertaken, the result would be that, eventually, the world would be less warm than it would otherwise have been! Catastrophic weather-related events would still occur, although less intense and perhaps less frequent. Very few voters, however, would readily understand such a nuanced outcome and remain committed over a prolonged period of time. On the other hand, we can comprehend and respond aggressively to the fact of rising oceans, floods, and the destruction from droughts and other severe weather. They are all clear and present dangers.

Federalism and Regional Economic Interests Canada and the United States have two vital similarities. Both countries cover vast tracks of land with huge ocean coastlines and both are well endowed with fossil fuels and food energy when compared to most other economically advanced nations. Furthermore, both Canada and the United States are federations. The federal governments in Ottawa and Washington represent enormous geographic territories encompassing widely different regional economies. Accordingly, state and provincial rights and regional politics are very important in both nations. Indeed, they are so important that the United States experienced a Civil War on the matter, even if 150 years ago. Arguably, that Civil War had a basis in differing energy regimes.7 Canada recently had a federal party, the Bloc Québécois, elected entirely from one province and dedicated to Quebec separation from the rest of Canada. Curiously, hydroelectric energy is a defining expression of Quebec nationalism.8 Similarly fossil fuels, and oil in particular, may be the basis of Western Canadian separatism. The Canadian federal government’s National Energy Policy of the early 1980s fanned the flames of separatism in Alberta. Although few took such Western Canadian separatist sentiment seriously—lacking as it did any basis in language or culture—it inspired a political backlash that did lead directly to the Canada-U.S. Free Trade Agreement and its Energy Chapter. That Agreement virtually ensured that the federal government of Canada would never again even attempt such an initiative.9 Canada’s regional political-economic complexity produces a Gordian knot for federal policy-makers on the matter of climate change. Much of Canada’s forecast of future economic growth rests on the presumption of continued strong growth in the energy sector. Almost everyone anticipates

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a continued westward shift in the economic centre of gravity in Canada. Indeed, it is already underway. At the core of this expected future economic development are the oil sands of Alberta and Saskatchewan—a highly controversial resource in climate change politics. It has a huge symbolic significance to environmental activists. The oil sands, or as environmentalists prefer “tar sands,” is very high on their “kill list.” It should come as no surprise, however, that those regions economically dependent on the production of fossil fuels will not embrace policies whose ultimate purpose is to reduce sharply, and perhaps even eliminate, their core industries. Moreover, rural, northern, and coastal ridings, heavily dependent on energy-intensive agriculture and resource extraction and processing, will not be fully supportive either. Nor will the concentrations of urban poor who spend disproportionately on energy, including food, readily understand the need for such a policy. And the suburban middle class in the Greater Toronto Area and other major cities who commute daily to work from homes that represent the bulk of their net worth—homes that will lose value when confronted with rising fossil fuel prices—may well resist. So what do Canada’s federal policy-makers do?10 What they must do anyway—follow the United States. Canada would not be allowed a “free ride” if the United States were to adopt an aggressive climate change program. Because Canada needs access to the U.S. market, U.S. politicians have all the leverage they need to get Canadian compliance. So if the United States “forces” Canada to accept an aggressive stance on global warming, then the political problem is no longer in the laps of Canadian federal politicians. They can defend themselves by saying, “The devil made me do it.” But of course that simply pushes the policy process in North America back into a deeply divided federal political space in the United States, whose population is no more inclined, or financially capable, of making more short-term sacrifices. Nor does the United States have fewer urban poor, a smaller suburban middle class, or less powerful agricultural or resource interests than Canada. The Great Lakes states, already struggling with the huge loss of manufacturing jobs, are heavily dependent on coal as the source of electricity production.11 The United States is also one of the world’s leading producers of fossil fuels, only fairly recently becoming second largest because of China’s enormous expansion of coal production.12 The U.S. production of fossil fuels is concentrated in several states.13 Unlike Canada’s Senate, however, the U.S. Senate is a decision body absolutely central to the entire federal legislative process. And the Senate of the United States is the ultimate manifestation of the power of regional politics—two senators from each state regardless of state population. When this fact is coupled with a recent Supreme Court decision, Citizens United v. Federal Election Commission, effectively granting corporations the same rights to “free speech” as individuals in political campaigns, the prospect of an aggressive domestic climate bill emerging from the U.S. Senate is very

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limited, both now and in the foreseeable future. And ratification of any international climate treaty requires a supermajority of two-thirds. The energy problems confronting our society are potentially deeply polarizing, pitting the interests of some groups and regions against others. In a polarized society, each side imagines that the essence of political leadership is to take decisions that experienced politicians know will be rejected by a very large segment of the population as wrong-headed—or worse, downright evil. But how do clear decisions constitute leadership if the result is almost certain to be electoral defeat and potential reversal of the policy at the next election? What’s more, is it really prudent for a democracy to jam a decision down the throats of a significant proportion of the electorate who fundamentally disagree—even if their disagreement seems to others to be “irrational”? It does not make society more stable. In such a world, rational political leaders may well take baby steps and simply hope to survive their watch. All difficult and complex choices are punted into the future, while hoping for the best. For the present at least, climate change has simply disappeared as a federal political issue in the United States.

“Take No Prisoners” Language As argued in the previous chapter, political communications are solely for the purposes of persuasion. Such communications are not driven by a desire to understand the nature of reality. They are driven by a desire to create a specific version of reality in the minds of listeners and observers. The use of fact and partial truth is meant to persuade others to a particular point of view. In order to do so, the language used often gets ramped up into clear choices between good and evil. Once again, psychologists have provided important insights into human cognition that informs such communication strategies. We now know that there are effectively two sets of programming running in our brains. One ancient set is designed for instant gut reaction. The other is programmed for thoughtful and slow deliberation.14 As we have seen, most people are not inclined to devote much thoughtful energy to politics. And, accordingly, political rhetoric is focused on the first type of programming. It is designed to reinforce instant gut responses. It appeals to our emotions—very often our fears, our sense of moral outrage, as well as our faith, our patriotism, our compassion. In respect of energy policies, we are not invited to ponder the difficult and technically complex trade-offs between technology types. We are simply told that there are good and evil technologies. For example, coal is evil; it is dirty. Sometimes the rhetoric is directed against nuclear energy because of the public’s fear of radiation. That this fear is irrational in the sense that people willingly expose themselves to more radiation in their dentist’s office

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or a hospital than from a nuclear power plant is beside the point. Or better yet, it is to the point. The more irrational the reaction, the more difficult it is to dislodge and the more resistant it is to alternative information or perspectives based on fact and reason. In these political communications wars, there is often a “take no prisoners” approach. When the enemy is evil, there can be no compromise. There is only total victory. But such victories are rarely achieved in a democracy. The battles for hearts and minds are typically prolonged. Accordingly, there must be symbolic victories in order to sustain the partisans’ enthusiasm for the fight. High-profile energy projects become prime targets for those seeking high-value, symbolic victories. Everything is thrown into the battle for and against a high-profile energy project involving fossil fuels. There can be no break with party line, on either side of the debate. As in war, the view becomes, “You are either with us or against us. And if you are against us, you are on the side of pure evil.” Woe to those who are selling a sober second thought approach. This is not a fight for the faint at heart, nor for the thoughtful scientist. Nor, ultimately, is it a place most politicians feel comfortable. There is no conceivable consensus. Rational politicians will know that elevating the sense of moral outrage on both sides of a debate can only end badly. They will know that the institutions for peaceful resolution of conflict can be torn apart by that type of language. This potential for escalation of language and moral stakes, of course, exacerbates tensions in the climate change debate not only domestically but among nations. Yet political competition can readily lead to an escalation of “take no prisoners” language. The Civil War in the United States is instructive in this regard. To think of the war in terms of competing energy regimes is not to diminish the central role that competing visions of human rights, political freedom, and morality played in the decisions to choose civil war as a method of domestic dispute resolution. But it would be wrong to think that future decisions about the choice of energy regimes will not equally be enmeshed in competing views of morality and political freedom. Whether or not these future competing visions can be resolved without resort to armed conflict is, of course, the ultimate test of any set of political institutions, both within nation states and among nation states on a global scale.

Global Leadership Limits The 1992 United Nations Framework Convention on Climate Change provided a foundation for international cooperation, as well as agreement on the need to stabilize GHG emissions in order to avoid dangerous climate change. Beyond this high-level general agreement, however, such subsequent international agreement as has been possible—the Kyoto Protocol in 1997, for example—has been led by those countries with no or rapidly diminishing reserves of fossil fuels, largely located in Western Europe.15

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Aside from their legitimate climate concerns, Western European nations have geopolitical reasons for wanting to reduce their dependence on fossil fuels. They have relatively little such energy supply. In short, the real cost of aggressive action on climate change by Western Europe is far less than it would be to large-scale suppliers of fossil fuels (such as Russia, North America, or the Middle East) or even large-scale, fast-growing users of coal (such as China or India). As we can see, domestic politics in the United States and Canada makes it very unlikely that North America can muster an aggressive policy on climate change. Both the United States and Canada are large-scale suppliers of such fuels, and they have far better prospects for continued economic growth than does Western Europe. As far as fast-growing newcomers to the growth club are concerned, they are overwhelmingly dependent on coal, the worst offender among fossil fuels. These nations also believe that the burden of dealing with the climate problem should be on those nations which are most responsible for the GHGs already accumulated in the atmosphere, and those nations with relatively high per capita incomes. Despite these differences, the nations of the world have recently agreed to a specific target of keeping the increase in global temperature to below 2°C. And it has been agreed that all nations have some responsibility, although not equal responsibility.16 Moreover, a fund to help the poorest nations cope with the challenges of climate change has been agreed to in principle. Large-scale aggressive action to reduce emissions across all nations, however, is not yet in sight. It is largely all promise and not much concrete action. In fact as noted earlier, forecasts by the International Energy Agency suggest that the world will not achieve its climate targets. Even the annual U.N. Framework Convention on Climate Change in December 2012 noted “with grave concern the significant gap between the aggregate effect of Parties’ mitigation pledges in terms of global annual emissions of greenhouse gases by 2020 and aggregate emission pathways consistent with having a likely chance of holding the increase in global average temperature below 2°C or 1.5°C above pre-industrial levels.”17 The same document also refers to a “pre 2020 ambition gap.” What countries promise and what they can achieve are two different things. For the targets and commitments to be achieved would require dedicated leadership not only from the European Union but even more importantly from both the North American and the Asia-Pacific nations. The United States and China must co-lead. They are the largest and second-largest economies in the world. They are the biggest producers and consumers of fossil energy. Together, they represent roughly 40 percent of global emissions of carbon dioxide, with China rapidly pulling ahead in total emissions. Unfortunately, serious bilateral relationship problems hamper their joint leadership potential.  The U.S. government is already expressing concern

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about the rapid build-up of China’s military capability. These concerns will only intensify as China closes the income gap with the United States and eventually overtakes that country in terms of the absolute size of its economy. Both countries now have an immediate political imperative to create jobs. With weak U.S. growth in domestic consumption and investment spending, and with further government stimulus politically hamstrung, the U.S. must get gains in its foreign trade sector.  China  accounts for most of the U.S. deficit in non-energy trade. But China, too, must create jobs to facilitate a mass exodus out of agriculture. And China’s high domestic savings rate and resulting export-driven economy are deeply embedded by culture and deliberate policy design. The potential for conflict over trade with the United States is ever present. But trade wars do not resolve anything; they certainly do not lead to mutual cooperation on other fronts. And there are problems on many other fronts. Each nation accuses the other of cyber-espionage. Moreover, there are flashpoints of political disagreement concerning Taiwan, Tibet, and North Korea. Perhaps the ultimate problem is that China’s economy and its recent economic progress are overwhelmingly dependent on coal. Over 70 percent of China’s primary energy comes from coal. Change will not be easy or swift. Nonetheless, while it is easy to imagine future conflict between China and the United States, it is also possible to imagine elements of great harmony. But it is a harmony that will not lead to rapid government action on climate change. China and other Asian nations need energy of all kinds, and North America could become an increasingly important supplier. Oil from the oil sands may soon flow to the Asia Pacific. Given the mounting price differential on natural gas between Asia Pacific and North America, liquefied natural gas exports are sure to head to Asia as well. Exports of coal are already increasing. In short, the growth dynamic in Asia could suck in all available energy supplies, without regard to climate change—at least for as long as climate changes do not scale up into a clear and present danger.

Conclusion Private markets or corporations, operating on their own, will not work to correct the problem of climate change, just as they have not worked to solve other environmental problems such as disease-causing smog, lake-deadening acid rain, or brain-disabling mercury and lead contamination. They have no incentive to do so. The problem requires a collective response. It is up to government to address this issue. But first, one must get domestic political consensus in North America. That requires facing up to domestic income-distribution problems. The weight of the argument here, however, is clear in that regard. The nature of the political market in the United States and Canada, coupled with the

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federal structure of our political institutions, suggests that our federal governments cannot act in a hyper-rational, pre-emptive mode. They are simply not designed to do so. In the current circumstances, federal governments in North America would struggle with the implied loss of economic growth, even if modest; they could fracture fatally when dealing with the far larger regional income redistribution that would necessarily be implied. Of course, even a collective national response is not enough. Given the nature of global warming, the solution must be a global collective response. It cannot be resolved by any one nation or even significant group of nations such as the European Union, which has other powerful motives for reducing fossil fuel dependence. There can be no material free-riders among the great nations of the world. But what would motivate the important fossil fuel–producing regions of the world to act aggressively? And what would motivate the very large and powerful developing nations, so heavily dependent on coal? From their perspective, the rich should pay. But will the tens of millions of rich people in China or India be allowed to hide their privilege behind the hundreds of millions of the very poor in their communities? It is hard to imagine that this will be acceptable. Accordingly, international agreement to forestall climate change seems a long way off, notwithstanding all the grand promises. In short, we are trapped by our beliefs and by the design of our organizations. We must proceed to experience the future, even though we possess knowledge, admittedly not certain knowledge, that the future could be very perilous. We are engaged in a global experiment on climate from which we cannot avert ourselves. We must wait for the future to unfold, and then we will bring all the resources of our communities to bear on the problems that present themselves.

Chapter Seven

Looking Forward Economic growth, largely through the instrument of more and better tools, has a comparatively short history in the human journey, perhaps 200 to 250 years. Nonetheless, economic growth has come to be our society’s primary objective, if not its only objective. The institutions we have built to advance the widespread use of markets and government protection of private property, particularly intellectual property, have been instrumental in our remarkable success in achieving our objective. Yet, as outlined earlier, Western market capitalism has a number of paradoxes and complexities at its philosophical core. More and better tools might not be automatically forthcoming unless the enormous productive potential of our tools is matched by an equal propensity to consume, by someone. Technological innovation, the core of productivity growth, requires government-sanctioned monopolies and other subsidies. Moreover, the modern corporation, a crucial and highly rational decision-making entity operating within markets that are predicated on the principle of individual reward and responsibility, has been granted limited liability. Furthermore, income inequality may be an unacknowledged motive for economic growth, and yet a threat to economic stability and therefore social and political cohesion. Our society, in short, is not designed for prudent action. It is designed to take risks. We have enshrined the principle of limited liability, not just in the private corporation but also in the way our governments are now expected to insure against corporate or personal miscalculations, if on a large enough scale. The problem is not that there is a lack of knowledge of risk, but that our institutions are designed in such a way as to ignore that risk. Our entire private and public institutional architecture socializes risk on a grand scale, even as it privatizes the upside reward. This includes environmental risk whenever and wherever the air and water are treated as free to private use, but there is actually a social cost. In large part this situation reflects a deep and unresolved, and perhaps irresolvable, ideological divide. A fully insured society should also be a highly regulated society if it is to avoid widespread moral hazard. But there is little doubt that an excessively rule-bound, government-dominated society

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suppresses creativity and is an open invitation to wasteful attempts to redistribute income to politically favoured groups, not to mention an assault on our individual freedom. On the other hand, we simply do not want to endure, perhaps cannot endure in our current political configurations, the heavy social costs of recessions and depressions and other economic dislocations. This philosophical divide is so embedded in our politics that the net result is a society with only a fast-forward gear. We cannot decide, so we try both. Our public policy is inclined to avoid regulation, to turn a blind eye, or even to deregulate to get the economy going, and then to bail out the overly aggressive risk takers and more generally pump up government spending as the economy contracts. Our modern community is extremely dynamic. That is its fundamental strength. It dares the future. Its fundamental weakness, of course, is that it opens itself to potentially catastrophic events. Nowhere is this more vividly illustrated than with respect to energy. Most of our material achievements to date could not have been accomplished without tapping into nature’s great storehouse of fossil energy. The world economy currently depends on fossil fuels for over 80 percent of its primary energy use. Depletion of these fuels, more resource wars, and the costs of significant climate change are somewhere dead ahead. But just when or how these phenomena will manifest is shrouded in deep complexity.

Increasing Complexity and Risk Yet none of our institutions, private or public, can avert us from our current experiment; nor can they willingly even slow it down. This is not an argument that our North American federal governments cannot act. It is an argument that they cannot act pre-emptively, particularly in respect of global warming or any other potential threat that requires clear short-run sacrifices in return for potential long-run benefits. At the same time, however, complexity and risk are compounding.

Increasing Globalized Complexity, Inequality, and Debt Notwithstanding their postwar success, the performance of the Western economies, the first movers in industrialization, has deteriorated over the past 30 years for a growing proportion of the population. Spiking fossil energy prices, in particular oil prices, have been instrumental in this development. They gave a significant boost to globalization of the economy. Western economies have a high-use, high-priced energy regime, with oil and natural gas representing a large share of their total primary energy consumption. In contrast, Asia Pacific still has a comparatively low-use, low-priced energy regime, with coal at its base. Corporate capital has responded to this simple but powerful economic reality. Since the early 1980s, mobile Western capital and global corporations

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have invested in, or sourced their products from, the less expensive energy jurisdictions, where coal is predominant and the diet and lifestyle of workers modest in terms of energy usage. At the same time, these corporations have innovated frantically in order to reduce unskilled labour inputs in their relatively high-cost Western operations. In the past 10 years, this type of innovation has been rampant, facilitated by information and communications technology. Machine intelligence, perhaps the ultimate nemesis of human capital, has rapidly ramped up. One result of these twin pincers has been that in the Western economies, low-skilled manufacturing jobs have almost disappeared. Jobs in high technology, marketing, administration, law, finance, and real estate have grown, but not nearly by as much as low-skill, low-wage jobs in the personal and retail service industries. Women have flooded the labour markets, but the participation rate of men is declining. The wage premium for skilled workers has also increased, but the untutored and unskilled have been further marginalized. The combined effect on families has been to deepen their drift into relative poverty and to trap parents and, more problematically, their children in such a condition. To be sure, Western economies have still grown in aggregate terms. Since the initial collapse in 1973, productivity growth has resumed, particularly in the United States. But the benefits of that growth have gone primarily to the few, not the many. The managers of the corporate empires have especially prospered. In the new version of the global economy, the fortunes of those at the very top of the income scale, for all intents and purposes, have decoupled from the fortunes of vast numbers of their fellow citizens. And that growth in income inequality has facilitated a vast rise in debt for both households and governments. Notwithstanding a nascent economic recovery from the sub-prime mortgage debacle, most Western economies are still mired in a no or low growth, high-unemployment swamp, even as less developed countries continue to experience rapid economic growth. And while households in the United States have begun the long process of reducing their debt, it remains at very high levels compared to the debt ratios that households carried in the 1960s and 1970s. This makes households highly vulnerable to future spikes in energy prices. For a disproportionate share of the population, spiking oil and food costs, along with contractually fixed debt service, squeeze out other household spending as well as new housing demand.

Increasing Geopolitical Complexity and Government Debt The rapid economic growth in nations outside the European–North American nexus, as desirable as it might be for some reasons, will not necessarily make the world more stable in geopolitical terms. As more national economies in Asia or elsewhere come to rival the economic and perhaps even military

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power of the United States, the stability that comes from a single global superpower will be lost. A more competitive world is not likely to be a more stable world, even if it is a more dynamic one. China, the emerging global superpower, cannot escape the complexities of market capitalism if it desires its benefits. A vast expansion of China’s productive capacity, if not diverted to domestic consumption, might have to be diverted to military consumption. But the rise of a competing naval power in the Pacific and Indian oceans will increase global complexity. For the United States, the existing global superpower, the burdens of a vast military and security budget that attempts to maintain global supremacy as well as security from terrorist attacks will compete with a politically popular set of social programs for funding. An aging “baby-boom” population wants security, from everything! This competition between military and social security will take place in the context of an already large government debt, swollen by recession.1 Those social programs now include universal health care insurance, but with no strong regulatory control on costs.2 And all these government expenditures, whether for military security or social insurance, are contingent upon continued economic growth—which may not be forthcoming at its historical rate.3

Declining Public Trust Along with economic performance, public trust in government has also declined. In part this reflects that poor economic performance. After all, the promise of post-WWII modern welfare state governments was that they would fix the problems endemic to a market capitalist society. Initially they did, even though it was the underlying economic growth that proved to be a “rising tide that lifted all boats.” Subsequently, however, disappointing economic performance has resurfaced a deep and unresolved ideological divide on the role of government. This ideological divide and declining public trust are exacerbated by the nature of the political marketplace itself. Political competition has produced a form of moral hazard in which politicians concerned about short-term electoral accountability and with no long-term accountability allow social risk to accumulate. Most people are uninformed, although not without opinion. Moreover, they are content to be so. The political arena is more like a courtroom than a scientific convention. And the only consequence of political speech in this arena is losing an election. Accordingly, a careless disregard of fact and reason dominates. One result has been an even more aggressive attempt at “branding” in order to reduce the opportunism and self-dealing of politicians. But this strategy has simply reinforced the deep and fundamental ideological divide that already exists in the philosophical core of our society. When coupled with the constitutional design of institutional checks and balances, including federalism, it tends to produce a paralysis of political leadership.

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The net result is that almost everyone agrees that government is failing—if still disagreeing on how and why. There is an exception to this typical paralysis, of course. On occasion we can rise above our differences. This political system can and does respond to a crisis—perceived as a clear and present danger. But our governments typically cannot act pre-emptively, at least on a large scale, to forestall crisis. They lack the consensual and collective trust required.

Looking Forward So every reader will no doubt wish to know how this story ends. Is this civilization—this set of socioeconomic and political institutions—doomed to hit an iceberg? Are we doomed by the inherent weaknesses in our private and public decision-making structures? The really inconvenient truth, of course, is that no one knows the answer to these questions. Complexity is complexity. It defies penetration. But does anyone really doubt that our institutions are highly likely to grind along, following their own internal logic? This is, after all, how we got rich. And so, I predict, it is how we are likely to proceed. We will sail on, trying to pick up speed.

Temporary Relief: Kick-Starting the North American Growth Engine Fortunately, North America does have one more card to play in the current circumstances. It is not from Keynesian-style fiscal stimulus, or a monetary stimulus that results only in asset price inflation. Technological change, along with the bounty of geography, is once again coming to the rescue. Hydraulic fracturing of shale formations has unleashed a potential energy supply bonanza—of both oil and natural gas. But it is particularly in natural gas that large new supplies have emerged. Natural gas prices have plummeted in North America. Household heating costs in many states have been reduced as a result. Coupled with milder winters, this alone will boost consumer spending. Low natural gas prices will lower electricity prices in regions where natural gas sets the market price of electricity. Fertilizer and plastics costs will also decline. The sharp reduction of natural gas prices has also made it cheaper to produce oil from the oil sands. The increase in North American oil supply from the Bakken and other shale formations, plus continued expansion of biofuels, will ease the price pressure on oil.4 Natural gas can substitute for oil in automobile and truck transportation. A low-cost option already being proposed is a federal mandate that all new automobiles have a “flex-fuel” capacity. This allows the vehicle to use methanol from natural gas and ethanol from cellulosic biomass as well as gasoline. The cost is estimated at a modest

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$100 per vehicle.5 Existing vehicles can also be retrofitted at reasonable cost to use natural gas.6 Lower energy prices will do far more than an enormous expansion of the money supply to kick-start economic growth.

Responding to Europe’s Immediate Crisis The current political struggles in Europe, especially the Euro-zone countries, are also instructive. There is no direct comparison to North America because the European Union’s energy resource endowments are far more meagre. But its institutions are similar, and the Europeans are the vanguard. The European Union is composed of advanced mixed-capitalist nations, with an expensive energy mix and heavy dependence on energy imports. Europeans have attempted to implement a highly ambitious economic and political idea, in an “old” society. They hope to impose a single market with a common currency on a population with pronounced geographical preferences reinforced by history, language, culture, differing social entitlements, and climate. Economic crisis has embraced the southern member states. Private banks and now governments need bailouts. Of course, this short-run solution requires even more integrated political-economic governance structures, and more rules. The European Union needs one pre-eminent fiscal and monetary policy, with an overarching sovereign credit. Notwithstanding a growing popular resistance, it is very likely to happen. The solution to the imminent failure of “too big to fail” institutions is almost always to make them bigger and more complex. But how will the new, bigger, and more complex structures cope with the prospect of repeatedly spiking energy prices, the effects of climate change, and a huge overhang of public debt, much of it originally private debt? The European Union may survive the current economic crisis, but these future mega-risks will not disappear. Indeed, the consequences of a future collapse might be even worse.

The Long-Run Energy Trap Despite the temporary relief offered by lower natural gas and oil prices in North America, as time passes the potential for energy price spikes is highly likely to get worse, not better. Natural gas prices in North America will not stay low forever. Low prices are, in part, an artifact of the isolation of the North American natural gas market from the global market. But this cannot and will not persist. It is reasonably certain that North American producers will want to export the temporary new surfeit of natural gas—even if natural gas does take a much larger share of the domestic transportation market. Even coal, or perhaps the energy content of coal, will enter more fully into international trade; in fact, this is already happening. Asia, in particular, does not appear to be able to fulfill its economic destiny unless all fossil fuels do enter more fully into global trade.

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Once North American natural gas enters more completely into the global marketplace, its price will be globally determined. Spiking global demand or geopolitically inspired disruptions of supply of natural gas could produce a similar drag effect as oil on parts of North America’s economy. The same could even happen to coal. If the global economy continues to unfold according to the prevailing paradigm, the billions of people in Asia and South America will converge in terms of income per capita and energy use per capita on the United States. Accordingly, the demand for energy will continue to press tightly on its supply (even as that supply increases in fits and starts). Moreover, a globalized energy industry will eventually equalize the overall price of energy, taking account of transportation, in each global region. The price of coal and natural gas will first rise sharply in the Asia-Pacific region. These price increases will induce available supplies from North America to find Asian markets. Capital, also being an internationally mobile resource, will relocate to or source its production from the low-cost energy jurisdiction until this happens. As machine intelligence increases, pressure on low-skill wages will continue from that quarter as well. Rising energy prices on a global scale will be the other side of the vice putting the squeeze on labour. No matter where located, low-skilled workers will have no respite. Of course, the promise of a global market is that it will yield a far larger world economic pie in the years ahead. The presumption is that the tendency toward equality of global per capita income among nations will be at a higher level for all citizens of those nations. This is possible, but not guaranteed. It is also possible that the current trend toward inequality within nations will persist and even grow for some time longer. The combined pressures of more low-skilled labour flooding into the global economy and emigrating in large numbers to North America, labour-saving technical change (that is net energy saving), and continued tight fossil fuel supply (even if still expanding) will continue to produce the same unequal income outcomes. For a large segment of the North American workforce, there may be no wage above the poverty line that also provides a job for all those looking for work. Such an economy and society will not be stable, for a variety of reasons. While the nation states of the world grow more equal in income per capita, neighbours in the same city may grow farther apart in income terms. No one said the rich in the global village all had to live in the same country. In fact, it is already obvious that they do not. Every developed and developing country has its one percenters, or even fewer, whose incomes have recently been pulling ever farther away from the vast majority in their communities. In such a world, the role of household debt, or perhaps government debt, or both must necessarily increase as well. In the short run, “hydraulic fracturing” may well be the technology fix that boosts energy supply sufficiently to rescue the North American economy, and even some parts of Europe, from the current economic

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malaise. But if so, the fix will likely be temporary. In the future, energy price spikes, potentially involving all fossil fuels and experienced across all regions of the global economy, will produce short-run macroeconomic consequences on a global scale. Accordingly, governments will have to continue to evolve in their ability to coordinate global macroeconomic policy, ex post of course.

The Ultimate Energy Trap: Climate Change As outlined in chapter 6, there are very few reasons to believe that climate change can be addressed before the fact. Neither our domestic North American nor our international political institutions are capable of dealing with the problem on a pre-emptive basis. Our federal systems of government encompass regional interests that will block climate change initiatives, including international agreements. But that same feature of our federal constitutions will allow some state and provincial jurisdictions to pursue those actions that are compatible with local politics. Subnational jurisdictions without significant oil production and that do not use much coal in their electricity production will lead, although from not too far ahead. The same will be true for fossil fuel–deprived jurisdictions around the globe, led by Western Europe. The overall result will be a patchwork quilt of policies (and explicit or implicit carbon prices) across North America and globally. Many large-scale businesses will resist such an approach, preferring a homogeneous, if perhaps modest, federal and even international carbonpricing initiative. But an overall federal or global policy that explicitly prices carbon emissions is unlikely to emerge. Our current politics cannot contemplate even a modest loss of economic growth; we could never endure the large income redistribution implied in any major climate initiative. Yet it is also very likely that governments will continue to fund research into the potential for large-scale, but low-cost, geo-engineered solutions to climate change.7 At the very least, geo-engineering could be seen as a fail-safe mechanism to be deployed if the impacts of climate change scale rapidly into a global disaster. Many environmentalists will object to such research for at least two good reasons. First is the potential for such engineering solutions to go horribly wrong. But even if things go well, this approach implies a moral hazard problem endemic to all insurance policies. The development of geo-engineering solutions may simply allow us to continue to take excessive risks and not alter our behaviour or the structure of our society. Of course, by the fundamental premise of this book, this is precisely why we can expect geo-engineering to be pursued. We socialize many risks both to pursue economic growth and to avoid political divisions for which we have no peaceable answers.

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Private markets will not directly tackle the problem of global warming. They have no incentive to do so. Yet they might produce outcomes that have the incidental effect of lowering carbon emissions. In North America, as noted above, there is a very good chance that natural gas will be substituted for oil in the transportation sector, resulting in lower carbon emissions. Natural gas is already being aggressively substituted for coal in electricity production. This is simply the result of market forces pushing down the North American price of natural gas in the face of an unexpected new infusion of supply from shale gas. Of course, governments could reinforce this substitution trend with new policies, claiming an environmental benefit in any case. As the globalization process continues, many if not most Western households will be compelled by the rising cost of energy relative to the wage of unskilled labour to consume less and less energy. North Americans have a high-cost fuel mix, with oil still the largest share. That will inevitably change. The global market, through an erratic and highly disruptive process of sharp energy price increases coupled with no real income growth for many households, will bring about the energy efficiency and conservation that public policy cannot engineer directly. Behaviour change will lead to less non-essential automobile travel; commuters will carpool or take mass transit. Many will no longer be able to afford a personal automobile. The suburban dream will pass. Urban density will increase. Housing space and meat consumption per person will decline. Automobiles and trucks will become far more fuel efficient. These are all favourable to the goal of reducing greenhouse gas emissions. Such changes may even be desirable for other reasons (such as the possibility of improved health outcomes from less excess caloric intake). Of course, North America will continue to use more energy per capita than Western Europe or Asia, but that will be because of the large share of resource industries and farming in its industrial structure. The really major substitutions for oil, coal, and natural gas are likely to continue to take place in Western Europe and, eventually, even in Asia. As noted, Western Europe appears at this point to have far fewer options than North America. Western European businesses, households, and governments are being compelled by energy security concerns and high import prices to lead in energy efficiency and renewable energy technologies. Asia—China and India in particular—may soon follow. Looming fossil fuel supply constraints are the reason. Asia has the opportunity, and the necessity, to do everything in a different fashion than North America or any other parts of the planet that are rich in fossil fuels. In all industrializing societies, there is a powerful trend toward concentration of population in cities. In the newly developing world, these are megacities. Construction resource requirements as well as transport requirements per person decline as urban density increases. We already have communications technologies that can make physical travel by individuals

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largely unnecessary. For the most part, only goods need move. There is even the possibility of widespread future deployment of virtual reality technology where physical resource constraints are no longer particularly material in our pursuit of personal experience. But it is also in energy supply that new technologies should emerge. Given Asia’s intense energy requirements relative to its domestic fossil fuel base, Asia should soon lead in solar and other renewable technologies. Again, this is not because of Asia’s concerns about climate change, but its overwhelming need for more energy if its economic growth is even to proceed. The production cost of solar panels for example, already falling sharply, could continue to decline in the context of a colossal Asian market. Biotechnology also offers the potential of a vast expansion of low carbon energy as well as carbon sequestration, while using marginal agricultural lands. These technologies could easily revolutionize the world of energy, and society along with it. As noted earlier, technology experts point to the evidence of Moore’s law in computing to indicate what is possible in respect of manufacturing basic technologies. Manufacturing experience is important. Trial and error is important. Large markets are critical. Asia, the new industrial centre of the world, has the potential for all of these powerful economic levers to take hold. Economies of scale, the phenomenon that helped make America’s Great Lakes states the manufacturing wonder of the world, may yet make China even greater.8 Private markets might also produce technologies that serve to significantly delay the depletion of fossil fuels. Technology may allow us to go deeper into the oceans to explore that vast and still largely unknown geology that constitutes 70 percent of the earth’s surface. Offshore drilling for oil and natural gas may yet profoundly change the outlook for fossil energy supplies. Governments everywhere, even the United States, have a direct commercial interest since they are the beneficiaries of resource rents from these offshore developments. In the deeper oceans, of course, there are difficult questions of ownership. The advent of hydraulic fracturing in North America is a vivid illustration of just how quickly any given prognosis of imminent depletion can be overturned by new technology. Nonetheless, while natural gas is less carbon intensive than coal or oil, it still emits carbon. If that carbon emission is not priced, then relatively inexpensive natural gas could delay introduction of renewable energies as well as new energy efficiency technologies. Indeed, in North America it is highly likely to do so. Cheap natural gas has already put a damper on new nuclear development, a less significant source of carbon emissions than natural gas, especially natural gas from shale (if there are disproportionate fugitive emissions of methane and the gas is to be exported as LNG).

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In the end, the official forecasters in the International Energy Agency, having taken account of many or all of these developments, still indicate that we are on a collision course with serious future climate change, unless we make some far more radical policy changes. So the conclusion holds that our current circumstances and our current institutions and beliefs lock us in, or trap us, to experience whatever lies ahead. Knowing that there could be a catastrophic problem ahead—based on a substantial consensus among scientists—will not save us from experiencing that problem and only then responding to it as a clear and present danger.

Can Capitalism, the Democratic Nation State, and Globalism Hold Together? Market capitalism, the nation state, and democracy are conjoined in a Goldilocks’ balance. Capitalism has at its core human motivations based in competitive accumulation and individual freedom; its internal logic drives inevitably toward its ultimate manifestation in a global market. Market capitalism also finds its most socially rewarding expression in competitive tool making. Accordingly, capitalism is also about change, indeed turmoil, as Joseph Schumpeter clearly articulated. Our tools are constantly changing and they, in turn, are constantly making and remaking our society. We are our tools. The Western version of market capitalism has worked well; fundamental individual economic freedoms and private property are protected from the predations and prejudices of dictators or of the democratic masses. The protections are embedded in difficult-to-change political constitutions. Nation states, at least in good times, have also promoted expanded international trade and the modern corporation. This model continued to develop and to work plausibly well for roughly a hundred years. Then the experience of two World Wars and the Depression of the 1930s, all in a 30-year span, demonstrated that peaceful and steady progress was not inevitable. Nonetheless, the nation state again responded by maintaining an appropriate level of aggregate domestic spending and introducing many social insurance programs. International trade was restored. The global corporation continued to evolve. The reformed version of capitalism performed spectacularly for the first 35 years after the Second World War. The presumption, and the experience, was that a rising tide lifts all boats. It was a Goldilocks’ world in which everything was not too much or too little, but “just right.” Then energy prices spiked in the 1970s and early 1980s, and spiked again after the millennium. Now the globalization of economic growth to Asia and other parts of the world has presented us with a new complexity. Can Western market capitalism, the nation state, democracy, and the globalization of economic

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growth go forward in happy concert? Can we sustain a growing divide between the circumstances of those living in rich neighbourhoods and those in poor or near-poor neighbourhoods in the same city? This divide is not just about a different level of material comfort, but also about relative social status. These two factors together affect the stability of families, the status of men in society, everyone’s health, and the chances for success of a very large number of children. And perhaps equally important, these differences affect how people think and how they view the future and therefore the community’s collective prospects for dealing with future problems. Poverty is not just about a lack of income; it is about a state of mind and about the poor decisions made within that state. At the core of our current economic malaise are constraints on the supply and nature of our energy resources. All we need is a vast expansion of low-cost, low-carbon-emitting energy and greater conversion efficiency in our technologies, particularly transport. As we have seen, this may not be so much a problem of technology, but of institutional design. It would be technically possible to vastly expand the supply of renewable or benign energy as well as produce far more energy-efficient tools. And it is certainly possible to have a quantum jump in energy-related research and development. But who is to undertake these tasks, and what is their incentive? Both our governments and our private corporations have their obvious frailties in this regard. Private markets will address the energy supply problem—but at their own pace and only in response to the incentive of higher prices. And they will do so without consideration for short-run macroeconomic implications and low carbon emissions. Nor can we turn to our governments. They are beset with inertia. Government is no longer trusted by many people on either side of the ideological divide. The growing number of swing voters or Independents is a further reflection of mistrust. So far, there is not even a political consensus on the nature of the problems and the central role of energy, let alone the appropriate solutions. Moreover, very few believe that such consensus will arrive soon. In this situation, governments can only respond to “a clear and present danger,” unmistakably recognizable to the vast majority. Government cannot be much of an instrument of forward-looking public policy if no one trusts the instrument.

The Power of Ideas: Could Society Be Redesigned? Of the many great modern economists, J. M. Keynes and F. A. Hayek have become the icons of the two opposing perspectives on the proper role of government in relation to the economy, at least in response to the type of economic crisis represented by a depression. Nonetheless, both men agreed absolutely on the fundamental power of ideas or beliefs.

Chapter 7. Looking Forward  127

Keynes in the midst of the Great Depression concluded his masterpiece, The General Theory of Employment, Interest and Money, by noting that “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than commonly understood. Indeed the world is ruled by little else” (383). Hayek, writing near the end of the Second World War in his most celebrated work, The Road to Serfdom, warned, “We are ready to accept almost any explanation of the present crisis of our civilization except one: that the present state of the world may be the result of genuine error on our own part and that the pursuit of some of our most cherished ideals has apparently produced results utterly different than those which we expected” (65-66). These two formidable thinkers have come to personify two philosophical camps that, while each possesses fundamental insights into the human condition, leave us profoundly divided. Our society has a deeply embedded institutional design flaw, along with a highly complicating and compounding consequence. The design flaw is the high degree of moral hazard that we have deliberately designed into our private and public institutions and programs. We want a lightly regulated society, but also a highly insured one. These objectives are not compatible, but we have chosen both. The complicating factor is the increasing income inequality in society. It has been indirectly responsible for a vast increase in household and now government debt in order to maintain aggregate spending. Such a society is highly vulnerable to future spikes in energy prices, or indeed any unhappy contingency. And that is not all. Inequality, in all its manifestations, makes it extremely difficult in a democracy to deal with problems that demand thought about the distant future and then prudent action with respect to those possible futures. In a sense, because the poor are trapped by their circumstances, so is everyone else. We not only hope for the best possible outcome. We need the best possible outcome. This is not prudent behaviour by anyone’s definition. The global energy mega-risks will continue to hound us until we resolve these complexities. Is there an integrating and liberating idea? Could we redesign our political institutions in an effort to remove or diminish their architectural defects? In principle, the answer is yes. But it would mean fundamental reform to the most cherished institutions and programs of those on both the left and the right of the political spectrum. Needless to say, it would meet with howls of protest and disbelief from both. My own forecast is that the moment for redesign will have to await some future calamity. We will have to hit an iceberg, probably a very big one. In the meantime, we are most likely to be governed by inertia. Institutions are resistant to change from within. Even when they fail to perform as predicted, they are not abandoned but are patched up and often pushed to more extremes of risk. We typically double-up on our bets.

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Society is a science experiment in real time. And we are part. We cannot simply think or debate our way to a better model. Our deep ideological divide is more likely to produce stalemate. We are trapped by our beliefs (institutions) just as surely as if we were in the Malthusian trap and just as surely as the Wall Street bankers were trapped, even as they believed themselves to be “Masters of the Universe.” Knowing the risk does not alter the trajectory. And so our experiment proceeds within its own compelling logic, with no real control by any single entity, and yet perhaps drawing ever closer to catastrophe. In the end, our most cherished ideas succumb only to calamity. Only out of the ashes of the old will the new emerge. Our youngest and brightest minds might well busy themselves with developing that new model of reality which could shape a future society. Being ready—armed with a new design when the old one clearly fails—is still the best advice to give wouldbe future policy advisors. What will be the shape of the new model? I have no crystal ball. But in my mind it will almost certainly be one that seeks to restore the role of individual responsibility throughout our institutions. It will attempt to diminish the role of “branding” and “money” and increase the role of fact and reason in politics. It will seek accountability for long-term results as well as short in all our institutions, including politics. No politician should be considered by history as successful just because he or she was reelected for a few terms. But the new model will also take account of randomness in the universe; it will make ensuring equality of opportunity, in all of its most relevant social dimensions, a priority social responsibility. The new architecture will vastly expand research and development on new environmentally benign energy-related technologies, whether on the supply or demand side. And it will be a society with far less debt, and of course with far less inequality of income and wealth as well. These are some broad possibilities. But whatever direction the future redesign might ultimately take, we could usefully heed the advice of that other giant twentieth-century intellect, Albert Einstein, who is reported to have said that “the significant problems we face cannot be solved at the same level of thinking we were at when we created them.”

Notes Preface 1 For ease of exposition, I use the term North America to refer to the United States and Canada only. While Mexico, a far more populous country than Canada, may yet emerge as a larger and richer economy than Canada’s in the North American context, it is reasonable at this stage to ignore its contribution. 2 By the term institutions, I am referring more generally to the values, customs, constitutions (written and unwritten) and organizations (for example, corporations, households, labour unions, markets, Congress, Parliament) by which we organize and govern our society. 3 The phrase “a clear and present danger” was first used by Supreme Court justice Oliver Wendell Holmes Jr. in a 1919 decision involving the First Amendment right to free speech; the issue was when the U.S. government had a right to deny individuals their First Amendment rights. In Schenck v. United States, Holmes wrote, “The question in every case is whether the words used are used in such circumstances and are of such a nature as to create a clear and present danger that they will bring about the substantive evils that Congress has a right to prevent.” The “clear and present danger” doctrine has been invoked in many cases since then. See The Free Dictionary by Farlex at http://legal-dictionary.thefreedictionary.com/ Clear+and+Present+Danger. 4 According to Kotowitz, “moral hazard may be defined as actions of economic agents in maximizing their own utility to the detriment of others, in situations where they do not bear the full consequences or, equivalently, do not enjoy the full benefits of their actions due to uncertainty and incomplete information or restricted contracts which prevent the assignment of full damages (benefits) to the agent responsible.” See Kotowitz, “Moral Hazard,” New Palgrave Dictionary of Economics Online. 5 We may be able to measure risk objectively, based on empirical evidence. But risk is also subjective, at least in the sense that people have different tolerances or preferences for even an agreed upon measure of it. What is “prudent,” therefore, appears to vary from individual to individual. But this empties the word of real meaning if we all have a different understanding of it. I believe that an objective standard of imprudent behaviour would be to take an existential bet where most of the material contingencies have to work out favourably for the wager to succeed. Effectively, this becomes an existential wager with a low or very low overall probability of a favourable outcome. This is what I characterize as not only hoping for the best, but needing the best. As a mundane example, consider a young couple that takes on a financial obligation which will end in personal bankruptcy (and possibly

130  Navigating on the Titanic worse) unless neither of them ever has a serious accident or illness; neither one is unemployed for more than a brief time; they never separate or divorce; and there are no unplanned children or other unanticipated financial burdens. That, I believe, in our current society would be an imprudent wager by anyone’s definition. Yet it happens all the time and would happen even more if lenders would permit it. Of course, this mythical couple could have parents, friends or neighbours who will act as a safety net. This book, however, considers this issue at a societal level, where the society itself has no safety net, unless it consciously decides to build one by restraining its current behaviour.

Chapter 1 Economies can grow by increasing the number of employed people (a reflection of an increasing population) and/or by increasing the income per worker. It is income per worker or, as it is loosely termed, “productivity” growth that ultimately allows workers to do more than simply feed, clothe, and shelter their families as well as themselves. Accordingly, it is the increase in income per worker and per capita that is our primary interest here. When the growth in income per worker is sufficient to raise income per capita, then it is at least possible that everyone is better off. Of course, whether they will be or not still depends on the distribution of that income. 2 Clark, Farewell to Alms. Not everyone would quite agree with this characterization (see Maddison, World Economy). Maddison shows that per capita income in Europe began to rise around the year 1000. He also documents an even sharper rise of per capita income in several maritime western European states in what he calls the Merchant Capitalist Epoch from 1500 to 1820. But it would be fair to say that most people in the world were still bound to a subsistence level of income. 3 Readers familiar with mathematics will know that anything increasing at a geometric rate (2,4,8,16,32,64,128…) will quickly reach an astronomical number compared with the more measured arithmetic rate of increase (1,2,3,4…). Sooner or later, population must reach a maximum. What if the population overshot the maximum? In Malthus’s view, food governed the limit, and the grim enforcer was mass die-offs operating through famine, war, pestilence, and disease. 4 But female fertility is an alternative control mechanism. In later versions, the Reverend Malthus, in response to the criticisms of his dismal forecast, did acknowledge that sexual self-restraint by the working classes may be possible, as well as from his perspective morally desirable. Of course, this is the secret. Sexual abstinence or some form of birth control, delayed marriage of women and then family planning remain our best tools for population control. Indeed, there is no evidence to suggest that these methods are beyond human capabilities and in fact quite the contrary in secularized, high-income societies. The European fertility rate, for example, has already fallen well below its replacement rate, as has Japan’s. Northern American fertility rates are slightly below replacement. 5 Strong social and religious beliefs that eschew birth control as immoral are slow to change. So are attitudes toward the appropriate role of women in society and the importance of their secular education. These beliefs are often reinforced in low-income societies by the economic risks that parents take of having too few children to support them as they age. These people can be said to be trapped by their institutions. 1

Notes  131 Maddison, World Economy, 382. Ibid. The population of Western Europe essentially doubled from 133 million in 1820 to roughly 261 million in 1913. 8 Ibid., 376. 9 United Nations, World Urbanization Prospects, File 1, “Population of Urban and Rural Areas and Percentage Urban.” 10 United Nations, World Urbanization Prospects, File 17a. 11 Ibid., File 1. In the United States it is 82.4 percent, in Canada 80.7 percent, and in France 85.8 percent. In China it is 50.6 percent and in India only 31.3 percent. 12 He also left out the effect of higher income on population growth. At some point, higher income appears to reduce fertility rates because it liberates the family to invest more in the quality of their children rather than the quantity. In this way, it also liberates women from fulfilling only their biological role in life. 13 With coal as the energy source, industrial production could take place in far more locations. In principle, any location could be industrialized if the economics worked. Production was no longer contingent on how much wind there was or how much water was flowing in the river. 14 I owe this definition to Ubbelohde, Man and Energy, 23. 15 For a beautifully written explanation, see Heilbroner, Worldly Philosophers, 94-96. 16 Ibid. 17 Sir Isaac Newton wrote his famous work, Philosophiæ Naturalis Principia Mathematica, in 1687. His work followed in a line of brilliant thinkers from Copernicus to Kepler to Galileo to Descartes. 18 Maddison, World Economy, 313. 19 Schumpeter, Capitalism, Socialism and Democracy, 81-86. The phrase “creative destruction” stems from the fact that while a new technology clearly creates, it also destroys the value of the old technologies and the jobs associated with them, as when the locomotive replaced the stage coach. Robert Solow is credited as the pioneer economist in developing rigorous mathematical models and empirical estimates of the contributions of various inputs, and of innovation, to economic growth. See also Helpman, Mystery of Economic Growth, 9-33. 20 Harold Innes, the University of Toronto political economist, began this work with his studies of commodities such as fish and fur and how their production technologies as well as the commodities themselves shaped early Canadian society. He later expanded this work by studying communications media and their role in empire building. Marshall McLuhan, the University of Toronto communications guru, developed these ideas further and captured the essential concept in his famous aphorism, “The medium is the message.” 21 This work follows in the tradition of the Russian economist Nikolai Kondratiev and, of course, Joseph Schumpeter. 22 That there are economies from agglomeration of separate firms in a specific geographic location has long been understood. The original ideas owe a great debt to the economist Alfred Marshall, writing in the 1920s. But now it has become a central object of public policy in order to spur technological innovation. 23 This statement needs to be qualified by concerns about the distribution of the growing income. It is possible that only a relatively few would garner most of the 6 7

132  Navigating on the Titanic income from economic growth. A “rising tide” does not necessarily “lift all boats” when it comes to the economy. One could also have economic growth and not growth in income per capita. It simply has not yet been our experience. 24 Knowledge has the intrinsic properties of a “public good.” A public good as defined by economists has two qualities. It is “non-rival” in its consumption. For example, knowledge or information can be possessed by virtually everyone simultaneously, and all are free to use it as they wish. It is also “non-excludable.” Again, knowledge or information fits because it is difficult to prevent others from acquiring once it exists. Therefore, inventors may not be appropriately compensated and invention may be discouraged. Based on this logic, governments in modern capitalist economies have focused on the need to reward private effort for the new knowledge embedded in the creation of new technology. Typically they have done this by granting a temporary monopoly patent to the technology’s inventor. The concept of a patent was given a major boost in England with the Statute of Monopolies in 1623. Even the early steam engines were patented. In the United States, the protection of intellectual property is in the Constitution. The first Patent Act was passed by Congress in 1790. A patent typically provides the right to exclude others from using the new knowledge for a period of time, but in return it requires disclosure of the knowledge by the patentee. 25 For an outline of the modern theory of economic growth and recent research on the role of innovation, markets, and other institutions, see Helpman, Mystery of Economic Growth. 26 Primary energy refers to such energy sources as solar, wind, hydro power (from gravity), geothermal, biomass, coal, oil, natural gas, and nuclear. There are also “manufactured” energy forms such as electricity, hydrogen, gasoline, diesel fuel, and jet fuel. 27 The process of invention itself may be subject to diminishing returns. This possibility has been suggested by anthropologist Joseph Tainter in The Collapse of Complex Societies, 117-23. He argues that specialization of function, giving rise to social complexity, is itself subject to diminishing returns and this includes the activities and bureaucracies devoted to research and development. He points to work by economists in the 1970s and 1980s studying the rate of return on research and development, whose findings support his contention. The economist Robert Gordon has recently published a paper pointing to the declining impact on income per capita of the latest round of technological innovation that is based on the computer and the Internet. See Gordon, “Is U.S. Economic Growth Over?” Other economists have also researched this issue; see Helpman, Mystery of Economic Growth, 34-54. 28 Each country had some unique differences in corporate design. Japan was the most different. 29 Maddison, World Economy, 381. The peak share of these nations was in 1950 when they represented 56.8 percent of the global GDP and 19.1 percent of the global population. 30 Clark, Farewell to Alms, 42. 31 Jevons, Coal Question, I.1. 32 Clark, Farewell to Alms, 334. 33 England’s coal production continued to rise until 1913. Jevons would not be the first forecaster, and far from the last, to predict inevitable depletion of any resource

Notes  133 available only in fixed supply. Society is complex. And it is virtually impossible to accurately forecast technological innovation over a long period. Jevons did, however, correctly predict that England would give way to the rise of another industrial and imperial power. And he accurately identified that nation. What he also missed is that it would not be one solely based on coal. 34 North, Growth and Welfare, 151. 35 Clark, Farewell to Alms, 308. 36 For an encapsulated history, see Yergin, The Quest. 37 See Yergin, The Prize. 38 Cited in Heilbroner, Economic Problem, 109. 39 Where E is energy, M is mass and c is the speed of light (approximately 186,282 miles per second). The massive release of energy from even a tiny mass is predicted by squaring the immense speed of light. 40 Three oceans if one considers Alaska and the Arctic Ocean. 41 This is Central Command, a unified military command headquartered at Madill Air Force base in Tampa, Florida. 42 For a review of the post-war development of Canadian economic and social policy, see Courchene, Policy Signposts. 43 Kennedy, “Remarks in Heber Springs.” 44 Keynes, General Theory of Employment. Lord Keynes referred to an economy in depression as having a “magneto problem.” A magneto is a generator that can be used as a source of electrical power for engines and telephones. 45 In the course of his analysis, Keynes wrote the following: “Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities” (161). 46 For a discussion of the role of “confidence” and other modern “Keynesian” insights into economic behaviour and performance, see Akerlof and Shiller, Animal Spirits. For a discussion of the application of Keynesian ideas to the most recent economic crisis, see Roubini and Mihm, Crisis Economics; and Stiglitz, Freefall. 47 It had long been accepted that banking crises and financial panics needed to be calmed by a “lender of last resort,” eventually a “central bank,” in order to contain the spread of panic and to prevent the merely illiquid banks as well as the insolvent banks from going bankrupt. 48 Cited in Greenspan, Age of Turbulence, 55. 49 Once again, for a general overview of research on institutions and economic growth, see Helpman, Mystery of Economic Growth, 111-42. 50 Adam Smith was, after all, a moral philosopher. 51 The English philosopher John Locke is credited with developing the intellectual relationship between possessing oneself and the personal right to possess other forms of property, indeed unlimited property. See McPherson, Political Theory of Possessive Individualism, 194-257. 52 Smith, Wealth of Nations, 941. 53 Smith goes on to note a governance flaw: “The directors of such companies, however, being the managers rather of other people’s money than their own, it cannot

134  Navigating on the Titanic well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.” Ibid. 54 This was recently affirmed by the Supreme Court of the United States in Citizens United v. Federal Election Commission, http://www.supremecourt.gov/ opinions/09pdf/08-205.pdf. Essentially, this decision has unleashed a torrent of corporate monies that can be used directly in U.S. elections. 55 Corporations are efficient decision makers with respect to cost reduction because they are designed to be efficient. Profit is not a cost of business; it is a residual payment. Because of this, profit also creates an incentive for the owners to drive out unnecessary cost. 56 Psychologists have demonstrated in laboratory experiments that people exhibit limited capabilities when it comes to rational calculation. We care, for example, about “fairness” and about our income relative to others in our group, perhaps as much as or even more than the absolute level of our income. This is not “rational” within the definition typically utilized in the models of neoclassical economics. Humans are especially challenged in the context of uncertainty or when confronted with randomness. Not surprisingly, strong emotions such as fear, disgust, hate, and euphoria play a role in our choices. We appear to have two sets of mental programming. One set is part of our more primitive past and reacts instantly, without hesitation. Then there is a more modern programming that houses our more deliberative mental abilities (for example our ability to reason). For a recent discussion by a psychologist and one of the pioneers of “behavioural economics,” see Kahneman, Thinking Fast and Slow; see also Mlodinow’s Subliminal and Drunkard’s Walk. 57 Some go so far as to suggest that since the corporation is hyper-rational and without compassion in its decision making, it exhibits a form of psychopathic behaviour. 58 Adam Smith in his Wealth of Nations reflected on this matter as did the economist Robert Heilbroner in Twenty-First Century Capitalism. 59 C.B. McPherson argued that it is possible that individuals are not driven by material accumulation and that political theorists of the seventeenth, eighteenth, and nineteenth centuries simply assumed materialism to be a given, as, of course, did their readers. See McPherson, Political Theory of Possessive Individualism. 60 Mlodinow, Drunkard’s Walk, 192-219. 61 There is a view that changing religious belief facilitated this development. Wealth was a signal of God’s favour. In a more secular vein, wealth may simply signal one’s superior abilities as well as one’s desirability as a mate. 62 The children of the poor are trapped by a complex combination of factors, including the fact that many poor families are headed by a single, divorced parent. A recent study reported in the New York Times documents a large and growing differential in standardized test scores between children from low-income families and high-income families. See Tavernise, “Education Gap Grows.” 63 Mortality rates in the United States vary greatly according to socioeconomic status. Unequal access to modern medicine is likely to be only a small part of the explanation. 64 The relationship of the individual to the nation state is usually modelled as a social contract. Individuality and personal freedom are well and good, except that they are operationally meaningless if one is open to the predations of whoever

Notes  135 happens to pass by—especially if the passersby have superior strength. Accordingly, in terms of political theory, the individual submits to the strictures and rules of the community, in exchange for the protections of the community. The key early philosophers were Thomas Hobbes, John Locke, and Jean Jacques Rousseau. As Hobbes saw it, submission to the authority of the sovereign (or the community) is the price for protection from a life that would otherwise be “nasty, brutish and short.” 65 The “size” of government is an elusive concept since governments can act in so many different ways—for example, through expenditures, taxes, guarantees, and regulations. Nonetheless, the minimalist activities include supplying those goods and services that can be labelled “public goods.” These “goods” include the legal frameworks and enforcement apparatus that establish markets; the protection of property rights including intellectual property; criminal laws; international agreements; some public infrastructures; as well defence of the state. Such a government, except in wartime, is modest in size and scope compared to the governments that are now commonplace in advanced Western economies. These governments have major social policy expenditures with the implied goal of income redistribution. Governments are not the only organization that can, or do, supply “public goods.” But the nation state has emerged as the dominant supplier for now because it typically has superior abilities to prevent “free riders” through fines or imprisonment. A “free rider” is, as the name implies, someone who enjoys the benefit of a service without paying. 66 Schumpeter’s process of “creative destruction” relies as much on the destruction taking place as on the creation or innovation. In short, markets must be allowed to work. Governments should not interfere; when they do, it often makes matters worse. Attempting to protect adult individuals from the folly of their choices can simply encourage bad choices. Another contemporary of Keynes who is frequently referenced as a proponent of letting markets work is F. A. Hayek. Hayek and Schumpeter were members of an intellectual tradition sometimes referred to as the “Austrian School” of economics. But countless other scholars have contributed. 67 Private insurance may not be available or may be prohibitively expensive to those known to be bad risks, for example health insurance for those with preexisting conditions. 68 Olson, The Rise and Decline of Nations. 69 This is a contentious observation. Elections are influenced by many factors, and it is not easy to predict outcomes with any persistent accuracy. Nor is it clear what aspect of economic performance will dominate at any particular time. Still, the state of the economy is consistently among the most dominant factors in electoral politics. For an up-to-date discussion see Silver, “Models Based on ‘Fundamentals’ Have Failed.” 70 Only in all-out war, and through compulsory military service, do we allocate the tasks of society in a different manner.

Chapter 2 1 Robert Gordon in his recent paper “Is U.S. Economic Growth Over?” points out that the really productive technologies, largely invented and certainly widely disseminated throughout society in the first 50 years of the twentieth century, were not

136  Navigating on the Titanic repeated in the next 50 years. He suggests that this type of invention, with its wide application and very high productivity impact, may not be repeated in the future. But his paper is especially interesting in terms of the thesis in this book because the new tools, and not the price of energy, get all of Professor Gordon’s attention. This is not unique. Other economists have fretted over the same issue. See Helpman, Mystery of Economic Growth, 51-54. 2 The title of this chapter borrows from Karl Polanyi’s The Great Transformation. 3 The data in this paragraph are taken from Maddison, World Economy, Table A.8 and Table 7.10. 4 See the U.S. Energy Information Administration, “Fossil Fuel Production Prices, 1949–2011” (Table 3.1). These data are producer prices, not consumer prices. Accordingly, the composite fuel price index reflects the relative proportions in which the fuels were produced in the United States rather than the proportions in which they were consumed. Since a large part of oil consumption is imported, this has the effect of underestimating the impact of these price increases on consumers when considering the composite index. The same is true for natural gas, increasing amounts of which were imported from Canada in this period. Nonetheless, the composite producer fuel price index is a good indication of what was happening to the cost of fossil energy in the U.S. economy, especially once the world price for oil was the accepted public policy. 5 U.S. Energy Information Administration, “Fossil Fuel Production Prices” (Table 3.1). 6 In 1981, the price of the energy content of oil went to $10.49 in real terms, up from $2.19 in 1972—an increase of 479 percent. Coal was at $2.27 and natural gas at $3.44 per million Btu compared to $1.24 and $0.65 respectively in 1972. The composite fossil fuel real price index surged to a peak at $5.26 per million Btu, over four times higher than the $1.31 it had been in 1970 (Ibid.). 7 The numbers in these two paragraphs are all taken from Maddison, World Economy, 345, Table 7.10. 8 In 1970, U.S. domestic expenditures on all primary energy and on petroleum represented 8 percent and 4.6 percent of GDP, respectively. By 1981, these expenditures had spiked to 13.7 and 8.5 percent of GDP. By 1999, the ratios had collapsed to 6 percent for all primary energy and a mere 2.8 percent for petroleum. Then in 2008 energy prices spiked again and these ratios went to 9.9 percent and 6.1 percent. U.S. Energy Information Administration, “Energy Consumption, Expenditures, and Emissions Indicators Estimates, 1949–2011” (Table 1.5) and “Consumer Expenditure Estimates for Energy by Source, 1970–2010” (Table 3.5). 9 Economists use the term elasticity to describe the brittleness or flexibility of a particular economic relationship. They typically distinguish between a short-run and a long-run elasticity. The logic is simple. The longer the period of time that elapses, the greater the adjustment—the elasticity—is likely to be. Some research indicates that the income elasticity of demand for gasoline has been increasing since the 1970s. This could correspond with decisions to buy a suburban home and a second automobile. At the same time the price elasticity of demand for gasoline has been falling. This suggests consumers get locked in by virtue of their previous capital decisions. 10 Our capital is long lasting. Automobiles can easily last 10 or more years. A typical suburban home will last at least 50 years and probably, with maintenance, 100

Notes  137 years or more. It takes over 20 years to get a complete fleet turnover of automobiles. Businesses are in the same position with respect to their capital. 11 Even Arab oil sheiks eventually invest their new revenues in buying oil field equipment and management services from Western countries, along with luxury goods of all kinds. They also invest in North American real estate and stocks and bonds of North American companies. But again, it takes time. 12 In 1949 the composite real price of fossil energy produced in the United States stood at $1.81 per million Btu. In 1999 it was $1.90 per million Btu. See the U.S. Energy Information Administration, “Fossil Fuel Production Prices” (Table 3.1). 13 China also needed a market, which it found in North America. Otherwise, it would have had to create a home market, with unforeseeable consequences for political control. 14 In 2009, the United States used 7.0 tons of oil equivalent per capita (toe/ capita); Canada used 7.5 toe/capita; Germany 3.9 toe/capita; France 4.0 toe/capita; United Kingdom 3.2 toe/capita; China 1.7 toe/capita; India 0.58 toe/capita; and Asia 0.66 toe/capita (International Energy Agency, Key World Energy Statistics 2012). 15 In 2011 in the United States, the price of coal was $1.83 per million Btu, natural gas $3.60 and oil $16.51. See the U.S. Energy Information Administration, “Fossil Fuel Production Prices” (Table 3.1). 16 These moves within North America reflected lower wages in these jurisdictions, often because of the absence of unions. The move into Canada reflected the wage-related advantages of public health care, a low-valued Canadian dollar, and later free trade. The health care and dollar advantages are now history. 17 The average annual productivity change in the U.S. non-farm business sector is shown in parentheses: 1947–1973 (2.8), 1973–1979 (1.1), 1979–1990 (1.4), 1990–2000 (2.1), 2000–2007 (2.5), and 2007–2011 (1.8). In the manufacturing sector, the years and percentages are 1987–1990 (1.8), 1990–2000 (4.1), 2000–2007 (3.9), and 2007–2010 (2.1). See U.S. Department of Labor, Bureau of Labor Statistics. 18 See Congressional Budget Office, Changes in the Distribution of Workers’ Hourly Wages. This report confirms a growing wage differential for high-wage over middle- and low-wage workers. 19 More recently, even some high-skilled workers have become vulnerable to low-cost offshore competition. The reason is that many high-skill service jobs can be performed at long distance with the benefit of information and communications technology. Perhaps as high as 25 percent of U.S. jobs are “offshorable,” and many citizens may be replaced by immigrant workers on special temporary visas, working for far less pay. “More than half of recent college graduates in the United States are either unemployed or are working in a job that doesn’t require a bachelor’s degree. Entry-level wages for employed college graduates were lower in 2011 than in 2000.” See Folbre, “How to Cut Skilled-Labor Costs.” 20 Congressional Budget Office, Trends in the Distribution of Household Income. 21 Organisation for Economic Co-operation and Development, Growing Unequal? 22 Overall household savings rates in the United States were, however, declining. The personal savings rate went from 9.4 percent in 1970 to 2.9 percent by 2000 and 2.4 percent in 2007 before recovering somewhat to 4.2 percent in 2011. U.S. Department of Commerce, Bureau of Economic Analysis, “Personal Income and Its Disposition,” Table 2.1.

138  Navigating on the Titanic There are countless books on this subject. For one by a long-time observer of American capitalism in action, see Phillips, Bad Money. 24 Sub-prime debt gets its name from the fact that the borrower typically cannot get funding from a mainstream bank or other financial institution. These borrowers do not meet the loan criteria that mainstream lenders require in order to secure their best or prime lending rate. Because these borrowers represent a higher level of risk, they must pay “sub-prime” rates, which are higher. 25 Household debt as a percentage of disposable income rose from 61.5 percent in 1970 to 67.9 percent in 1980 to 82 percent in 1990 and 92 percent in 2000. It peaked at 128 percent in 2007, before dropping to 112 percent by 2011. Calculated from data found at the U.S. Department of Commerce, Bureau of Economic Analysis, “Personal Income and Its Disposition,” Table 2.1 and the Federal Reserve Bank of St. Louis, Economic Research, “Household Sector: Liabilities.” 26 Mortgage interest is tax deductible, and the government-sponsored, now government-owned, financial institutions Fannie May and Freddie Mac in the United States support the market for mortgage lending by insuring the debt or in fact acquiring the mortgage debt themselves. 27 The rate of home ownership increased from 61.9 percent of households in 1960 to 66.2 percent in 2000. U.S. Department of Commerce, Census Bureau, “Historical Census of Housing Tables.” 28 Edelman, “Poverty in America.” 29 Deparle, Gebeloff, and Tavernise, “Older, Suburban and Struggling.” 30 The combined GDP of 27 countries of the European Union is slightly larger than that of the United States. The combined GDP of the 17 countries of the Euro area is, however, smaller. 31 Because of differences in language, custom, and history, there is less internal labour mobility in Europe than in the United States. This is an enormous problem in a single currency area when regional imbalances of trade develop. Restoring trade balance presents people with two equally unpleasant options—move or take a wage cut (including reductions in government-provided benefits). Actual cuts to pay are extraordinarily difficult to achieve. And aside from the bitterness of war over many centuries, the Greeks, Italians, and Spaniards, for example, prefer to live where they do and speak their national language. Only time will tell if these nation states—each so deeply steeped in their own histories, languages, and cultural identities—are willing to surrender even more of their sovereignty to a bigger political and economic idea. 32 Reinhart and Rogoff, This Time Is Different. 33 At the time of writing, many are simply buying back their own shares, unable to find better investment opportunities. 34 There is a famous “liquidity trap” in Keynesian economics whereby increases in the supply of money are simply absorbed into idle balances, with no impact on spending. 23

Chapter 3 Deng Xiaoping, who came to power in 1978, is credited with being the Chinese leader who transformed the nation’s economic institutions and set the basis for 1

Notes  139 China’s rapid economic growth. In 1979 China also adopted the famous “one child policy” in order to gain control of population growth. 2 The market capitalism of Asia is different from that of Western Europe or North America. The state plays a greater direct role, certainly compared to North America. Is this important? At this stage it does not appear to be so. But no doubt these differences will become the subject of intense future examination. 3 For a discussion of these issues by a renowned international development economist, see Sachs, Common Wealth. 4 United Nations, World Population Prospects. 5 We need to know the composition of their diet as well—for example, its plant versus animal composition. Meat consumption requires more energy input per calorie of output than cereal consumption. 6 The growth in the demand for electricity to power televisions, refrigerators, air conditioners, and a host of other appliances is highly income elastic. But perhaps nothing connotes a North American lifestyle as much as ownership of an automobile. Indeed there are more automobiles in the United States than there are licensed drivers. But China has already surpassed the United States in new automobile sales. Accordingly, between 2000 and 2011 Chinese oil consumption more than doubled. The International Energy Agency expects the passenger vehicle fleet in the world to double to 1.7 billion by 2035. Non-OECD countries will account for most of the increase. 7 U.S. Energy Information Administration, International Energy Outlook 2011. 8 “Over the next 25 years, 90 percent of the projected growth in global energy demand comes from non-OECD economies; China alone accounts for more than 30 percent, consolidating its position as the world’s largest energy consumer. In 2035, China consumes nearly 70 percent more energy than the United States, the second-largest consumer, even though, by then, per-capita energy consumption in China is still less than half the level in the United States. The rates of growth in energy consumption in India, Indonesia, Brazil and the Middle East are even faster than in China.” See International Energy Agency, “World Energy Outlook 2011 Factsheet.” 9 See Wolfram, Shelef, and Gertler, “How Will Energy Demand Develop?” 10 Most developing nations that are rich in a particular energy source are also profligate in their use of that resource. Accordingly, a future energy resourceconstrained world is most likely to reflect the energy use in a developed economy that is already experiencing relatively high-priced energy. Europe seems like a good example. 11 International Energy Agency, Key World Energy Statistics 2012. 12 See, for example, Heinberg, Party’s Over; Deffeyes, Beyond Oil; and Simmons, Twilight. For a somewhat different perspective, see Yergin, The Quest. 13 Shale oil is a light grade crude oil found in dense shale. It is not to be confused with oil shale, a much different lower grade of petroleum product. See Yergin, The Quest. See also U.S. Energy Information Administration, “Review of Emerging Resources.” 14 The oil sands, for example, have potentially 1.8 trillion barrels of oil in place. This is far more than the 175 billion barrels that the Alberta government claims are recoverable with current technology and economics.

140  Navigating on the Titanic The U.S. Energy Information Administration has completed a study of a select number of countries to determine the global potential for shale gas. It discovered a huge potential addition to the “technically recoverable” reserves of natural gas. This means that the economic viability of the resource has to be demonstrated before it can be added to the “proven reserves” category. Nonetheless, “to put this shale gas resource estimate in some perspective, world proven reserves of natural gas as of January 1, 2010 are about 6,609 trillion cubic feet, and world technically recoverable gas resources are roughly 16,000 trillion cubic feet, largely excluding shale gas. Thus, adding the identified shale gas resources to other gas resources increases total world technically recoverable gas resources by over 40 percent to 22,600 trillion cubic feet.” See U.S. Energy Information Administration, World Shale Gas Resources (5 April 2011). 16 We are also talking about the demand for personal and family transportation services that are convenient, speedy, comfortable, and safe. 17 This technique converts the coal to a gas and then uses various chemical processes to produce synthetic liquid fuel. The process was heavily used by Germany in the Second World War. 18 See for example, Heinberg, End of Growth, and Martenson, Crash Course. 19 The oil industry used to be dominated by seven major, privately owned oil companies in the West—originally called the “Seven Sisters.” Now national oil companies (NOCs) control the majority of proven oil reserves (85 percent in 2010) and current production (at least 55 percent in 2010). See U.S. Energy Information Administration, “Who Are the Major Players?” 20 To complicate matters further, each member of the public may have a different tolerance for risk. 21 U.S. imports of oil are, however, forecast to decline sharply from 9.2 MMb/d in 2010 to 7.5 MMb/d in 2035 (U.S. Energy Information Administration, Annual Energy Outlook 2012, Table A11. 22 It also illustrates Canada’s extreme dependence on the U.S. market for its exports of oil and heavy oil in particular from Alberta and Saskatchewan. This is a dependence that has recently been costly as U.S. production of shale oil and biofuels has ramped up. Canada’s heavy oil has been trading at a sharp price discount to sweet, light crude oil. This price discount explains the high priority the Canadian federal government puts on finding a way to get the oil to the Asia-Pacific region. Environmentalists and other opponents to the oil sands development hope to keep the vastly increased production capability bottled up in Alberta, unable to go west through British Columbia or south through the United States to the Gulf coast. 23 Although a net oil exporter, Canadians use imported oil to serve the market east of Montreal, with some imported products also flowing to Ontario. With the oil price increases of the 1970s and early 1980s, Canadians did initially enjoy lower than world prices for oil. However, the possibility that this would continue was in effect surrendered in the Canada-U.S. Free Trade Agreement and subsequently in the North American Free Trade Agreement. Under the Energy Chapters of these agreements, Canadian and U.S. consumers must be treated equally in the event of an international supply disruption. While Mexico did not sign on to this part of NAFTA, for all intents and purposes it is most useful to think of North America as a single entity when considering matters of energy security or, indeed, energy policy in general. Notwithstanding Canada’s status as a net exporter of oil, spiking oil prices 15

Notes  141 have caused significant industrial dislocation in the non-oil-producing provinces, particularly Ontario. 24 Canada is a member but does not have a strategic reserve because it is a net oil exporter. Nonetheless, Canada does import oil to eastern Canada, some of which goes as far west as Ontario. But a pipeline does exist from Sarnia and Nanticoke, Ontario, to Montreal. This could be reversed to supply Western Canadian crude to refineries in Quebec and the Atlantic provinces. 25 Of course that same oil embargo and price spike produced the stagflation that would bedevil nuclear construction projects with higher costs, particularly higher financing costs. In addition, these projects came on stream in the midst of deep recession in demand. Such are the complexities of real life. 26 See International Energy Agency, Key World Energy Statistics, 2012, p. 17. 27 Greenspan, Age of Turbulence, 463. 28 This section owes much to Yergin’s The Prize (1991) and Klare’s Resource Wars (2001) and Blood and Oil (2004). 29 See Yergin, The Prize. 30 Saudi Arabia sits on the eastern shore of the Red Sea, a key waterway leading to the strategic “chokepoint” of the Suez Canal, a vital link to the Mediterranean Sea and Europe. 31 Countries covered by CENTCOM include Afghanistan, Bahrain, Egypt, Iran, Iraq, Jordan, Kazakhstan, Kuwait, Kyrgyzstan, Lebanon, Oman, Pakistan, Qatar, Saudi Arabia, Syria, Tajikistan, Turkmenistan, United Arab Emirates (UAE), Uzbekistan, Yemen, Syria, Lebanon, Djibouti, and Seychelles. 32 The data on oil reserves, production, and consumption are drawn from BP Statistical Review of World Energy June 2012, 6-9. 33 The pricing and output decisions of owners of oil resources are extremely complicated. The economist Harold Hoteling first outlined the optimum depletion rate for a non-renewable resource in a paper published in the Journal of Political Economy in 1931. Essentially the issue becomes how quickly one should convert an asset safely stored in the ground into cash to be invested in other assets. The answer is that it depends on one’s forecast of future resource prices compared to the return available from other current financial assets. This is further complicated by the fact that many energy-producing countries now have very large holdings of financial assets in the West. Withholding oil can cause oil prices to spike, recessions to ensue, and the value of these financial holdings to decline. That is not all. The resource owners must also consider the availability of substitutes and the possibility of a technological breakthrough that could reduce the value of their resource. And if this is not enough to complicate matters, in many oil- and gas-producing nations, by far the dominant portion of all government revenues comes from the sales of these resources. Maintaining political control requires that some portion of these revenues be paid out to key interest groups and often even the general public, for example as subsidized energy consumption. Therefore, production decisions are dictated not only by current and forecast oil prices and rates of return on other assets but also by domestic political requirements for current income. A further complexity, for example, is Saudi Arabia’s relationship to other major oil producers such as Iran and Russia. This relationship may be important in the Saudi decision on production in the context of the Iranian nuclear program and the deteriorating political situation in Syria.

142  Navigating on the Titanic BP Statistical Review of World Energy June 2012, 20. These numbers can be expected to change dramatically as the full impact of shale gas around the world is assessed. 35 The potential for shale gas may dramatically change this picture, especially for France and Poland. See U.S. Energy Information Administration, “World Shale Gas Resources” (5 April 2011). 36 Almost all the uranium fuel for the European Union reactors is imported. 37 Current estimates of technically recoverable reserves put China as number one, ahead even of the United States. The estimate for China is 1,275 trillion cubic feet and for the United States 862 trillion cubic feet. This is a vast expansion over China’s 107 trillion cubic feet of proved reserves of natural gas compared to 272.5 trillion cubic feet in the United States (U.S. Energy Information Administration, “World Shale Gas Resources”). 38 BP Statistical Review of World Energy June 2012, 30-34. 39 The atmosphere is made up of several layers above the earth—the troposphere, stratosphere, ozone layer, mesosphere, and ionosphere. 40 See Yergin’s The Quest (419-520) for a highly readable account of the development of climate-change science and politics. 41 Nitrous oxide is also a greenhouse gas that is formed from the interchange of nitrogen in the soil and the atmosphere. Livestock, rice paddies, and landfill sights are also a major source of methane (natural gas), a particularly potent greenhouse gas. There are also unintended or “fugitive” emissions of natural gas from pipelines and industrial facilities. 42 Aside from the complications of other GHGs, warming also depends on how much cloud cover there is, other particulate matter produced by human activities, and particulate matter from volcanic activities. All three act as a barrier to the sun’s rays striking the earth. But clouds are particularly important since they could either enhance or reduce global warming. There are also complex calculations with respect to the uptake of carbon dioxide into the oceans, not to mention the delayed warming of the oceans. 43 There is an enormous literature on these impacts. But it is best to start with the UN Panel on Climate Change. 44 See, for example, Lomborg, Cool It. 45 Nordhaus, Question of Balance. 46 There is methane gas that is frozen into the tundra and trapped in deep sea ice formations—gas hydrates. This highly potent GHG could be released, much accelerating the warming effect. Similarly the polar ice, having melted, would no longer reflect some of the sun’s rays back into space. Instead, the sun’s rays would be absorbed by the oceans, speeding up their warming and again releasing methane now dissolved or trapped there. Polar ice may melt from the bottom, as well as the top and simply slip into the ocean, raising sea levels rapidly. On the plus side, more CO2 in the atmosphere could speed up the growth of trees and the absorption of more CO2. 47 International Energy Agency, “World Energy Outlook 2011 Factsheet.” 48 Not everyone agrees with this statement. Some believe that the existing alternative technologies are not sufficient or cannot be scaled sufficiently to meet 34

Notes  143 the targets. Experts reasonably disagree. One needs to experience the future to determine who was right, and why. 49 Most experts, but not all, view biomass as a “carbon-neutral” fuel. The biomass takes the carbon in, utilizing it and effectively storing it as it grows, and then releases it when it is burned. The debate usually centres on how much fossil fuel is used in growing, processing, and transporting the biomass to its point of use. The same debate takes place around nuclear, wind, hydro power, solar, or any other energy source. These sources of energy all currently use fossil fuels in their construction and the manufacture of their components, particularly steel and cement. 50 These calculations for natural gas depend on where the gas comes from and what transformation it must go through before reaching its destination for being utilized. Accordingly, caution should be exercised and the source of the natural gas or oil or coal determined. 51 Expert debate continues on the viability and cost of carbon capture and sequestration, and nuclear energy, both key technologies to replace simple coal combustion in a carbon-constrained world. Both are hugely expensive and difficult to scale up to the degree necessary to make significant reductions in emissions from coal. 52 For example, the estimates for Canada are quite modest. See the National Round Table on the Environment and the Economy, Achieving 2050. Estimates by the U.S. Congressional Budget Office show similar modest reductions of annual growth. 53 This includes our need to deforest large areas of the world in order to expand cropland, certain farming practices, as well as the general human preference for meat consumption.

Chapter 4 In political terms, “necessities” is a relative concept. It inevitably varies from country to country according to the overall standard of living in each country. 2 In general, systems that exhibit geometric rates of growth or decay—that are non-linear or subject to power laws—play an important role in the notion of an “apocalypse” because they can quickly spiral out of control, or to borrow a phrase from biology recently made popular in respect of social ideas, “go viral.” In the presence of power laws, an apparently minor event can produce very big effects that seemed inconceivable beforehand. This is sometimes referred to as the “butterfly effect.” War, communicable disease, pestilence, and famine (these latter two specifically now related to climate change) all potentially have this property. 3 There is a difference between risk and uncertainty, which economist Frank Knight has pointed out in his book Risk, Uncertainty and Profit. Risk can be calculated on the basis of previous experience. It allows for prediction. Uncertainty refers to those situations where we cannot reasonably predict anything. For some it represents a total lack of predictability—no prior knowledge at all and the potential for complete surprise. But it is also possible that our predictive models are simply wrong. We may be vastly underestimating the probability of certain events because we have not yet penetrated the complexity of their origin. We may have assumed the wrong probability distribution. We may not even know what it is that we need to know—what the former U.S. Secretary of Defense referred to as “unknown unknowns.” And such events could be catastrophic in their impact. 1

144  Navigating on the Titanic Oil price spikes are not now a “black swan.” We know this can happen. We have seen it frequently in the past 40 years. And we know the rough results. 5 U.S. Energy Information Administration, “What Are the Major Sources?.” 6 Of course, if executives were held accountable, not just for paying back money but including the serious possibility of prison, it would change everything. Some have argued that this is what should be done in the case of taking willful environmental risks as well as financial risks. See, for example, Nocera’s article “How to Prevent Oil Spills.” 7 Greenspan, Age of Turbulence, 523. 8 For example, mortgage originators quickly sold the mortgages to others and so no longer had any interest in the ability of the mortgagee to pay. Credit rating agencies have a conflict of interest in that they are paid by those whose debt they rate. Insurance companies such as AIG provided credit default swaps, effectively insurance against default, without adequate financial reserves to deal with the possibility of widespread defaults. 9 Opinion polls in the United States indicate that the public has far more trust and faith in technology corporations than in other public or private institutions. See Allen, “United We Stand ... on Technology.” 10 To get a taste of the differences in perspectives, see Catton, Overshoot, and Ridley, The Rational Optimist. 11 As noted earlier, certainly not every economist believes that technology will keep producing dramatic increases in productivity. Robert Gordon, in his paper “Is U.S. Economic Growth Over?,” is perhaps the most recent to speculate that the really productive technologies, which were largely invented from 1850 to 1940 and were not repeated in the next 60 years, may not be repeated in the future. 12 As we have outlined earlier, notwithstanding predictions to the contrary, the old energy sources are still annually increasing in output, thanks to new knowledge. New oil is also coming from hitherto inaccessible sources and places, such as “tight oil” in shale or deeper offshore. 13 Information technology has already reduced the need to commute to work or to the shopping mall. 14 In the transportation and energy sectors, almost nothing has fundamentally changed in the past 30 years or longer. But of course that fact alone is not a reliable basis for a long-range forecast of future energy or transport technologies. The basic internal combustion engine survives because it continually wins the competitive race that we collectively set for it. 15 We do not know what we do not know. We cannot be certain that technology will solve our near- or long-term energy problems without calamity intervening first. We do not know if we can scale up even known technologies to the extent required in the timeframe that may be available. Nor do we know whether a technological breakthrough will lead to even greater, unanticipated problems. What we do know is what we have been able to accomplish to date. These accomplishments give us confidence in our abilities with respect to the future. 16 Tainter, The Collapse of Complex Societies. 17 The American Energy Innovation Council reports that “across all U.S. industries, private firms spend an average of 3.5 percent of revenues on R&D. By contrast, 4

Notes  145 utility spending on R&D averages 0.1 percent of revenues.” See Catalyzing American Ingenuity, Chapter 1. 18 As noted earlier, energy sources are differentiated products in some degree. This is why they have become specialized in different uses. But innovation in the energy sector tends primarily to be process innovation, driving down the cost of finding, developing, extracting, transporting, or distributing. Machines can be differentiated on the basis of their energy-using characteristics.

Chapter 5 The banking sector in the United States was heavily regulated from the Great Depression of the 1930s until the “supply-side” revolution in the 1980s. Deregulation then took hold of economic policy in the financial sector, as it did in other sectors of the economy, right up until the crisis of 2008. The last vestiges of the Glass-Steagall Act of 1933, for example, which prohibited banks, investment banks, and insurers from common ownership, were removed during President Clinton’s administration in 1999. Financial deregulation initiatives continued under President George W. Bush. 2 There is a very large Public Choice literature in economics on “government failure.” On balance, it reminds us of the obvious fact that governments too are staffed with mere mortals—that is, self-interested people. 3 Politicians must perform this task in return for a modest income compared to their private corporate counterparts. Moreover, there is no incentive pay. This presumably reflects the fact that there is no single metric of the public interest comparable to “profitability.” Re-election is, hopefully, one’s only bonus reward. Lack of high financial reward may attract individuals who are less inclined to such rewards. More likely, the psychic rewards of being “centre stage” and a powerful actor in society are considerable compensation to those who select this life. Financial rewards after a political career may also be considerable. 4 The threat of filibuster means that anything less than 60 votes is considered unwise. Thus 41 senators, who could represent a small fraction of the U.S. population, can prevent passage of a bill. 5 A majority government in a parliamentary democracy such as Canada’s centralizes a great deal more power in the Cabinet, and indeed in the Office of the Prime Minister. The Canadian prime minister is a uniquely powerful political executive. Canadian federalism provides for more direct power to the provincial legislatures but does not have as important or formal a regional voice in the federal legislative process as that of the U.S. Senate. 6 Downs, Economic Theory of Democracy. 7 It is why we have a secret ballot. 8 The “public interest” may have no definition other than it is what emerges from our constitutionally defined, collective decision processes. Everyone is free to imagine that what is in his or her private interest is also in the public interest. Hence everyone may claim to have the public interest at heart. 9 Of course, we have to be reasonably certain that we can actually discern character accurately from whatever information we focus on as an important indicator of character. Some would dispute our ability to do even this. 1

146  Navigating on the Titanic These numbers are all from the Center for Responsive Politics, “Historical Elections, Election Stats 2010.” 11 Center for Responsive Politics, “2012 Presidential Race.” For a discussion of various aspects of fundraising for federal elections, including the impact of the Supreme Court’s decision in the case of Citizens United v. the Federal Election Commission, see Harwood, “With Elections Awash in Cash.” 12 Center for Responsive Politics, “Historical Elections, Election Stats,” several years. 13 See Akerlof, “Market for Lemons.” 14 This is similar to the “adverse selection” problem in insurance. Only the bad risks stay in the insurance market and hence in the pool of insured persons. Costs rise further as the good risks are driven out. As a result, insurance simply becomes too costly for everyone. 15 This is a combination of adverse selection and moral hazard. 16 See Pew Research Center, Trends in Political Values. 17 For a discussion of how reason has been a victim of modern political competition, see Gore, Assault on Reason. 18 See Kahneman’s Thinking Fast and Slow for a review of modern research in psychology by a Nobel prize-winning pioneer of behavioural economics. 19 For the most part, behavioural economics rejects or eases the central behavioural assumptions of neoclassical economics that individuals are rational and purely self-interested decision makers. 20 We each of us harbour some model, however fully developed, of how the world works, or at least the part we care about. Usually we filter all information looking for confirmation of our views. This is highly unlikely, however, to lead to a useful understanding of reality. Science on the other hand progresses because its models of reality are subjected to the requirements of logic and mathematics and thence to the requirement for predictions that can be empirically tested. Every part is open to intense and continuous scrutiny and debate by experts in the field. While not perfect, this process has been remarkably successful. 21 Jeffrey Sachs uses this phrase in another context in his book, Common Wealth, 40. 22 Reinhart and Rogoff, This Time Is Different. 23 In 2011 the United States had net imports of 8.5 MMb/d. Roughly 36 percent or 3.1 MMb/d came from Canada (28.7 percent) and Mexico (7.5 percent). The other 5.4 MMb/d came from non-North American sources such as the Persian Gulf, Nigeria, and Venezuela. These imports represented roughly 28.7 percent of total U.S. oil consumption in that year. U.S. Energy Information Administration, “U.S. Net Imports by Country.” 24 To get consumers to use 29 percent less oil, on a permanent basis, would require a far larger percentage increase in its price (because it is price inelastic) or physical rationing as in wartime. The latter is even more unlikely than the former. 25 Military bases need back-up power in case of emergencies. The ultimate energy security for any individual military unit is to carry all the necessary energy with it, without the need for long and exposed supply lines. Fossil fuels are certainly not ideal in this regard. While the United States may not be motivated to abandon fossil fuels any time soon, the U.S. military may be intensely interested in the alternatives, if only for battlefield purposes. 10

Notes  147 American Energy Innovation Council, Catalyzing American Ingenuity, note 11. Belasco, The Cost of Iraq. 28 Pew Research Centre, “Future Full of Promise and Peril.” 29 If indeed, notwithstanding the political marketing, the invasion of Iraq was a form of pre-emptive energy policy, it can serve only as a warning of the dangers of undertaking a policy without explicitly stating the objective. As of this writing, all U.S. combat troops have left Iraq. It is very doubtful that this was the original intent. It seems reasonably clear that the intention was to leave a permanent and fairly large garrison. Moreover, the potential for armed clashes between Shia, Sunni, and Kurdish forces remains. This might easily incite further unrest in the entire region. In short, despite the near trillion dollar cost to the U.S. treasury and the short-term impact of higher oil prices on the world economy, potentially very little has been accomplished. 26

27

Chapter 6 See Courchene and Allen, Canada: The State of the Federation 2009. A carbon tax would be applied to carbon dioxide, along with a corresponding equivalent tax on other greenhouse gases, depending on their greenhouse effect. Given that many if not most nations subsidize the use of fossil fuel in various ways, the agreed carbon tax would have to be on a net basis after deducting these various subsidies. The net tax would have to be the same anywhere on the globe and enforced by the local national government, although under the surveillance of an international body to ensure compliance. Clearly, “trust” would play a large role. 3 Carbon capture and sequestration is considered technically feasible with respect to coal. It is, however, very expensive and cannot yet be deployed economically on a wide scale. The gas has to be captured pre- or post-combustion, compressed and pumped deep underground into salt reservoirs covered by natural vaults, where it must remain forever. Carbon dioxide would have to be transported by an extensive set of pipelines from the coal-fired generating stations to the underground storage locations. Probably pre-combustion capture would be best at the coal fields, requiring the coal to be turned into a synthetic natural gas first. But such a solution then requires all existing coal plants to be replaced. The expense would be enormous. 4 When a democratic community confronts increasingly difficult political choices, it almost inevitably begins to punt those unpleasant choices into the future through the mechanism of debt finance. The borrowing may be a straightforward addition to the government’s outstanding debt or it may be disguised in many ways. “Creative” accounting did not start or end with Enron! For example, Western governments have made rich pension commitments to their unionized employees and to their military personnel (including medical, disability, and death benefits because wars have long tails of cost associated with them), not to mention the commitment of universal health care. The full implications of these commitments can be submerged in unrealistic assumptions about future financial returns on pension assets or economic growth and therefore government revenue growth. This is no problem as long as the economy does indeed continue to grow. 5 In Canada, the prime minister is particularly powerful by virtue of the manner in which the rank and file of parties choose (or remove) their leaders. The prime minister ultimately controls a candidate’s right to run under the party banner, controls 1 2

148  Navigating on the Titanic ministerial and other senior government and agency appointments, receives constant media exposure, and legislates at will in a majority government. 6 Pew Research Center, “Modest Rise.” 7 In 1861 the Civil War broke out in the United States. The war pitted a rapidly industrializing North based on wood and water power, and increasingly based on coal, against an agricultural plantation economy in the South based principally on slave labour. At first the issue was contained to debate around the matter of property rights to be recognized when adding new states to the Union. Eventually, it centred on irreconcilable moral conceptions of property and individual liberty. Exceptional military leadership in the South confronted overwhelming military force in the North. The Northern army had 1 million more men in arms than the South. The North controlled the bulk of the manufacture of arms, and its navy successfully blockaded the South. Yet what followed entailed the bloodiest battles ever experienced to that date in history. The war lasted until 1865. 8 Indeed, one could argue that because electricity production and distribution are regional industries, and each Canadian province has a provincially owned utility involved in this activity, each province has used its energy policy as a defining tool of public policy. Ontario has done this with nuclear power; Alberta, Saskatchewan, and Nova Scotia with coal; and most of the rest with hydroelectric power. 9 The Agreement would require that Canada extend any preferential pricing of energy to its existing U.S. customers. Needless to say, no one would contemplate such an initiative. 10 It should be noted that the Liberals under Stefan Dion campaigned in 2008 on a version of a “carbon tax.” They were roundly defeated and the leader was replaced with a new leader who dropped the carbon tax proposal. 11 Over 40 percent of U.S. electricity production comes from coal-fired facilities (42.3 percent in 2011). For the key Great Lakes manufacturing states the proportions in 2011 are as follows: Indiana, 85.3 percent; Michigan, 54.0 percent; Ohio, 77.7 percent; Minnesota, 54.2 percent; Pennsylvania, 48 percent; Wisconsin, 63.1 percent; and Illinois, 45.1 percent. Calculated from U.S. Energy Information Administration, Electric Power Annual, Tables 3.6 and 3.7. http://www.eia.gov/electricity/annual/. 12 The United States in 2011 produced 1,501.4 million tons of oil equivalent of fossil energy (oil, natural gas, and coal). Russia produced 1,215 million tons. Saudi Arabia produced 615.1. China produced 2,051 million tons of oil equivalent, of which 1,956 million tons was coal (up from 809.5 million tons in 2001). Calculated from the BP Statistical Review of World Energy June 2012, 10, 24, 32. 13 The top coal-producing states are Wyoming, West Virginia, Kentucky, Pennsylvania, Texas, and Montana (U.S. Energy Information Administration, “What Is the Role of Coal?”). The top five oil-producing states are Texas, Alaska, North Dakota, California, and Oklahoma. Offshore production in federal jurisdiction is by far the largest oil source (U.S. Energy Administration, “Five States Accounted for about 56%”). For marketed natural gas production, the top five states are Texas, Louisiana, Oklahoma, Wyoming, and Colorado (U.S. Energy Information Administration, “Top 5 Producing States”). 14 See Kahneman, Thinking Fast and Slow. 15 Canada was a signatory to this Protocol but did not come even close to achieving its agreed reduction target; indeed, its total emissions increased. Canada has since repudiated its target commitments under the agreement and will not agree to

Notes  149 an extension of the Kyoto Protocol unless all countries, including developing countries, are covered. The United States, under President Clinton, and Vice President Gore presiding over the Senate, never signed on. It also wanted any international agreement to cover all countries. Russia signed on but has since adopted a position similar to the United States and Canada. Japan, also a signatory to Kyoto, has adopted the same position. 16 The Copenhagen Accord (December 2009) was not a consensus agreement but established certain elements such as a global temperature target (2˚C) and the principle of “common, but differentiated responsibilities and respective capabilities.” The Accord also obtained emission limitation pledges (including India, China, and others); established developing-country reporting (under “clearly defined guidelines”); created funds for REDD (deforestation and forest degradation); created funds to assist developing nations (to adapt and mitigate) of $100 billion/year from public and private sources by 2020; as well as provided for a technology-transfer mechanism. Subsequent annual meetings have produced consensus agreement on these elements and a commitment to establish a new international agreement to replace Kyoto by 2015 to be implemented by 2020. The recently completed Doha round of international climate talks extended Kyoto (which covers only a small portion of global GHG emissions) but remained vague on most of the details of the various commitments. 17 United Nations Framework Convention on Climate Change, “Advancing the Durban Platform.”

Chapter 7 1 The official recorded debt of the United States in 2012 was roughly $16 trillion, and the debt held by the general public was $11.6 trillion. Economists Laurence Kotlikoff and Scott Burns, in The Clash of Generations, use a concept known as “fiscal gap accounting” to estimate the actual debt in 2011 at a whopping $211 trillion. 2 There is a large intergenerational transfer implicit in the various social insurance programs. Each generation gets more benefits than they paid in as taxes. The young of tomorrow are expected to finance the benefits for the old today. Medical costs are rising dramatically faster than wages. Once again someone else is expected to pay, and there is no incentive for politicians to stop pushing the cost onto the future. The future does not get a vote. Whether future generations will pay or not is part of the existential risk we confront. Kotlikoff and Burns document the enormous unfunded liabilities of the U.S. government in their recent book, The Clash of Generations. 3 Gordon, “Is U.S. Economic Growth Over?” 4 Various current supply bottlenecks with respect to oil will also soon be resolved. The Keystone XL pipeline is likely to get the go-ahead from President Obama. The extra oil now available in the interior of North America will get to coastal ports and the appropriate refining capacity. More will be exported and imports will decline. 5 See McFarlane and Woolsey, “How to Weaken the Power of Foreign Oil.” Biofuels and natural gas have the long-run advantage of being less carbon-intensive than oil. 6 Small vehicles typically use compressed natural gas while large long-haul trucks can be fitted to use liquefied natural gas. It is estimated that 40 percent of new garbage trucks and 25 percent of new transit buses in the United States use

150  Navigating on the Titanic natural gas. And natural gas may soon take 20 to 25 percent of the new tractor trailer vehicle market. See Motavalli, “Natural Gas Signals a ‘Manufacturing Renaissance.’” 7 Geo-engineering refers to large-scale efforts to block incoming solar radiation (for example in the manner that the ash from erupting volcanoes does) or to sequester larger amounts of carbon in trees or algae or in the deep ocean as well as underground. 8 Protectionism might be our political response. The U.S. government is applying anti-dumping charges against inexpensive solar panels from China. Economies of scale are one thing, but will the Chinese match America’s inventiveness? Indeed, if we in the West are truly fearful of anything in Asia, it is that Asians will surpass us in the novelty and usefulness of their tools.

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152  Navigating on the Titanic Courchene, T.J., and J.R., Allen, eds. Canada: The State of the Federation 2009. Carbon Pricing and Environmental Federalism. Montreal and Kingston: McGillQueen’s University Press, 2010. Deffeyes, K.S. Beyond Oil: The View from Hubbert’s Peak. New York: Hill and Wang, 2005. Deparle, J., R. Gebeloff, and S. Tavernise. “Older, Suburban and Struggling, ‘Near Poor’ Startle the Census.” New York Times, 18 November 2011. Diamond, J. Collapse: How Societies Choose to Fail or Succeed. New York: Penguin Books, 2005. Downs, A. An Economic Theory of Democracy. New York: Harper & Brothers, 1957. Edelman, P. “Poverty in America: Why Can’t We End It?” New York Times, 28 July 2012. Federal Reserve Bank of St. Louis. “Household Sector: Liabilities: Household Credit Market Debt Outstanding.” Graph. Updated 6 December 2012. http://research. stlouisfed.org/fred2/series/CMDEBT?cid=32256. Folbre, N. “How to Cut Skilled-Labor Costs.” New York Times, 30 July 2012. http://economix.blogs.nytimes.com/2012/07/30/how-to-cut-skilled-labor-costs/?src=recg. Gladwell, M. The Tipping Point: How Little Things Can Make a Big Difference. Boston: Little, Brown and Company, 2000. Gordon, R.J. “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds.” Centre for Economic Policy Research, CEPR Policy Insight No. 63, September 2012. http://www.cepr.org/pubs/PolicyInsights/CEPR_Policy_Insight _063.asp. Gore, A. The Assault on Reason. New York: Penguin, 2007. Greenspan, A. The Age of Turbulence: Adventures in a New World. New York: Penguin Books, 2007. Paperback edition 2008. Harwood, J. “With Elections Awash in Cash, There’s Plenty of Blame to Go Around.” New York Times, 22 June 2012. Hayek, F.A. The Road to Serfdom: Text and Documents, The Definitive Edition. Chicago: University of Chicago Press, 2007. First published 1944. Heilbroner, R.L. The Economic Problem. 3rd ed. Upper Saddle River, NJ: PrenticeHall, 1968. —. Twenty-First Century Capitalism. Concord, ON: House of Anansi Press, 1992. —. The Worldly Philosophers: The Lives, Times, and Ideas of the Great Economic Thinkers. New York: Simon and Schuster, 1980. Heinberg, R. The End of Growth: Adapting to Our New Economic Reality. Gabriola Island, BC: New Society Publishers, 2011. —. The Party’s Over: Oil, War and the Fate of Industrial Societies. Gabriola, BC: New Society Publishers, 2003. Helpman, E. The Mystery of Economic Growth. Cambridge: Harvard University Press, 2004. International Energy Agency. Key World Energy Statistics. 2012. http://iea.org/ publications/freepublications/publication/kwes.pdf. —. “World Energy Outlook 2011 Factsheet: How Will Global Energy Markets Evolve to 2035?” http://www.worldenergyoutlook.org/media/weowebsite/factsheets/ factsheets.pdf. Jevons, W.S. The Coal Question. Library of Economics and Liberty, 1866. http:// www.econlib.org/library/YPDBooks/Jevons/jvnCQ.html. Kahneman, D. Thinking Fast and Slow. Doubleday Canada, 2011.

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About the Author Bryne Purchase is an adjunct professor at the School of Policy Studies, Queen’s University and a Fellow (and the founding director) of the Queen’s University Institute of Energy and Environmental Policy. He is a former chief economist and deputy minister of Finance, of Revenue, and of Energy, Science and Technology in the province of Ontario. He has a PhD in economics from the University of Toronto and is the author and editor of a number of publications relating to economics, governance, and competitiveness.

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Measuring the Value of a Postsecondary Education, Ken Norrie and Mary Catharine Lennon (eds.) 2013. ISBN 978-1-55339-325-2 Immigration, Integration, and Inclusion in Ontario Cities, Caroline Andrew, John Biles, Meyer Burstein, Victoria M. Esses, and Erin Tolley (eds.) 2012. ISBN 978-1-55339-292-7 Diverse Nations, Diverse Responses: Approaches to Social Cohesion in Immigrant Societies, Paul Spoonley and Erin Tolley (eds.) 2012. ISBN 978-1-55339-309-2 Making EI Work: Research from the Mowat Centre Employment Insurance Task Force, Keith Banting and Jon Medow (eds.) 2012. ISBN 978-1-55339-323-8

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From Innovation to Transformation: Moving up the Curve in Ontario Healthcare, Hon. Elinor Caplan, Dr. Tom Bigda-Peyton, Maia MacNiven, and Sandy Sheahan 2011. ISBN 978-1-55339-315-3 Academic Reform: Policy Options for Improving the Quality and Cost-Effectiveness of Undergraduate Education in Ontario, Ian D. Clark, David Trick, and Richard Van Loon 2011. ISBN 978-1-55339-310-8 Integration and Inclusion of Newcomers and Minorities across Canada, John Biles, Meyer Burstein, James Frideres, Erin Tolley, and Robert Vineberg (eds.) 2011. ISBN 978-1-55339-290-3

A New Synthesis of Public Administration: Serving in the 21st Century, Jocelyne Bourgon, 2011. Paper ISBN 978-1-55339-312-2 Cloth ISBN 978-1-55339-313-9 Recreating Canada: Essays in Honour of Paul Weiler, Randall Morck (ed.), 2011. ISBN 978-1-55339-273-6

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Making the Case: Using Case Studies for Teaching and Knowledge Management in Public Administration, Andrew Graham, 2011. ISBN 978-1-55339-302-3

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Afghanistan in the Balance: Counterinsurgency, Comprehensive Approach, and Political Order, Hans-Georg Ehrhart, Sven Bernhard Gareis, and Charles Pentland (eds.), 2012. ISBN 978-1-55339-353-5 Security Operations in the 21st Century: Canadian Perspectives on the Comprehensive Approach, Michael Rostek and Peter Gizewski (eds.), 2011. ISBN 978-1-55339-351-1

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The Democratic Dilemma: Reforming Canada’s Supreme Court, Nadia Verrelli (ed.), 2013. ISBN 978-1-55339-203-3 The Evolving Canadian Crown, Jennifer Smith and D. Michael Jackson (eds.), 2011. ISBN 978-1-55339-202-6

The Federal Idea: Essays in Honour of Ronald L. Watts, Thomas J. Courchene, John R. Allan, Christian Leuprecht, and Nadia Verrelli (eds.), 2011. Paper ISBN 978-1-55339-198-2 Cloth ISBN 978-1-55339-199-9

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