EROI and theories of value

Dec 8, 2018Energy economics, EROI

Conventional economists’ rejection of EROI

Conventional economists usually reject net-energy analysis. The assumption is that the price system embeds all the energy and non-energy costs, and therefore there is nothing to be gained by a narrow focus on energetic costs. The challenge for proponents of net-energy analysis is to explain how a hypothesis based, in part, on an `energy theory of value’ can be reconciled with the empirical observation that market prices regularly reflect relative scarcity unrelated in any meaningful sense to energy resources. Clearly, energy is only one of many scarce factors of production. This post is intended to shed some light on the Biophysical Economists’ conception of energy and economic valuation.

Value as deriving from the concept from objectivist or intrinsic factors

Prior to the late 19th century marginalist revolution, wealth was believed to derive from intrinsic or objective qualities. Historically, the principle `objectivist’ factors were land and labour. The idea of intrinsic value was that all other value derived from those intrinsic factors.
The idea was encapsulated in Quesnay’s classification of economic agents in 18th century France. The `proprietary’ class comprised landowners; the `productive’ class comprised agricultural labourers; and the `sterile’ class comprised merchants and artisans. Merchants exchanged and accumulated wealth, but Quesnay argued that they didn’t create wealth. The entire wealth of a nation was assumed to derive from the land, as a result of such activities as agriculture, mining, and forestry.

Francois Quesnay (1694 – 1774)

Many other factors have been suggested as possessing an intrinsic value, independent of price. I have identified 11 major theories of objectivist value including land, labour, gold, electricity, energy, emergy, exergy, money, human action, information, and social relations – see table below.
From the early modern period, the objectivist notion of value had been undermined by the `water versus diamonds` paradox. Adam Smith argued that value can have two different meanings – `value in use’ and `value in exchange’. Water is essential for life but is often abundant, and therefore may not command a high price. In contrast, a diamond has little `use value’ but `a very great quantity of other goods may frequently be had in exchange for it.’

Marginalism

A resolution to the paradox occurred in the late nineteenth century and came to be termed the `marginalist revolution‘. It is generally ascribed to Jevons, Menger, and Walras. Marginalism is the idea that value or utility is related to `the next unit’ of a product or service, and is connected to scarcity and exchange value rather than some intrinsic quality. From a marginalist perspective, the French merchants contributed to wealth to the degree that consumers paid for the service that merchants provided. The carting, trading, and provision of credit created `intrinsic’ value in relation to the profit margin. Conventional, or neoclassical economics, as it is practiced today, emerged from the marginalist revolution.
Although the adoption of market valuation seemed to resolve the longstanding paradox, the complete rejection of intrinsic value also led to a major shortcoming – an inability to properly value non-renewable natural resources, or fully value the cost of wastes and pollution. The idea of `marginalism’ made it much harder to correctly identify the role of natural resources, especially energy, in economic growth. Instead, beginning with Solow, `technical innovation’ came to be adopted as the primary explanation of economic growth. In the context of energy supply and storage, it is often assumed that the solution lies in technical progress. This reflects a belief in the power of markets to drive technology.

Biophysical Economics

Biophysical Economists, or proponents of net-energy analysis, believe that it is impossible to understand macro-economic trends without adopting an objectivist or intrinsic valuation of energy. Whereas prices only matter when they are too high, energy return on investment (EROI) only matters when it is too low. EROI is a cost, rather than a price, metric that reflects an underlying biophysical constraint. At the limits, energy IS the economy.

Comparison of objectivist theories of value

Theory	Proponent/s	Comments
Electricity	Beaudreau	A production function based on capital, labour and electric power provides a closer correlation to economic growth in the US, Germany and Japan
Energy	Technocrats, Sgouridis	Value is determined by the energy content of all materials and work. May include an energy-based currency.
Exergy	Keen, Ayres	Exergy-based GDP measurement inherently distinguishes between benefits and costs (or `goods’ and `bads’)
Gold	Austrian School of Economics	Adherence to a gold standard reduces price inflation, and reduces exchange rate volatility. Gold underlies fiat currencies.
Human action	Graeber	Intentional or productive action aimed at a certain goal produces social relations and in doing so transforms the producers themselves.
Information	Kurzweil	There is a rapidly increasing knowledge and information content in products and services, and that these are not constrained by material resources. Economies are driven by data and knowledge.
Land	Petty, Quesnay, Cantillon, Physiocrats, Han China (2nd century BC)	Land and sunlight are the origins of wealth. Manufacturing and commerce are `unproductive’ or `sterile’. A flourishing and well-managed agriculture meant a satisfied people and a large surplus, which the imperial government could use to support its rulers, bureaucrats, and armies
Labour	Smith, Ricardo, Marx	Physical capital embodies previous labour. Ricardo noted `Possessing utility, commodities derive their exchangeable value from two sources: from their scarcity, and from the quantity of labour required to obtain them.’
Money	Sumner	A stable relationship between money and the economy requires a predictable or modest controlled expansion of nominal GDP.
Social relations	Strathern, Dodd	Objects (e.g. a pig or shell) embody social relations. For Dodd, money is a social link through which social relations of interdependence and conflict are resolved.
Sunlight	Odum	Emergy is the available solar energy used up directly and indirectly to make a service or product

[bctt tweet="EROI and theories of value"]