This is a quick follow up to last week's post on the Wealth of Nations: Using the 2012 BP Statistical Review of World Energy.
In that article, I noted that the Purchasing Power Parity GDP is a better means of comparing the wealth of a nation with the wealth of the US compared with the nominal GDP. The nominal GDP between the US and other countries is biased towards Japan and Western Europe, and biased against China, India, Russia, and Canada. Though, the PPP GDP still appears to be biased against Russia and Canada; and in this post, you'll see that the real GDP growth rate often does not track the growth rate in the capability to do useful physical work.
In this post, I'll comparing the Real GDP growth rates in the US with the growth rates in Total Work Generated. In addition, I'll be plotting the population growth in the US, which has been fairly constant over the last three decades at roughly 1.1%/yr.
The data for the Real GDP comes from the World Bank. The excel files can be found here. The data for the Total Work comes from the 2012 BP Statistical Review of World Energy and a site for historical vehicle efficiency. As in the last post, Total Useful Work is calculated as "Total_Electricity_Generation[TWh] + (Oil_Consumption[MToe] + Biofuel_Consumption[MToe])*Efficiency_Converting_Fuel_to_Work[%]*11.6 [TWh/MToe] + Natural_Gas_Consumption[MToe]*0.6*0.1*11.6 [TWh/MToe]"
Note that 11.6 is the conversion factor between Millions of Tons of Oil Equivalent and TerraWattHours. 0.6 is roughly the amount of natural gas used to heat homes and cook, and 0.1 is the rough efficiency of using combusted natural gas to maintain the temperature gradient required to heat the home and to cook food.
Below is the graph that includes yearly growth rates in (1) Real GDP,
(2) Total Useful Work Generation, and (3) Population. Also included in
this graph are the historical averages between 1985 and 2011: 2.6%/yr, 1.9%/yr, and 1.1 %/yr, respectively. Note the wild swings in both Real GDP and Total Useful Work. There were three major economic downturns between 1985 and 2011:
1989-1991, 2000-2001, and 2007-2009 (the largest by far). Note also the dips close to or below 0%/yr don't last that long. It's almost like people fool themselves into thinking that X is a good investment (where X is housing, computer tech stocks, etc...), and then as soon as they realize that they made a bad investment, they make wiser decisions on how best to invest their time, money and work.
We can make some general conclusions from this graph: (1) Population growth can account for some of the growth in GDP/Total Work, but it can't account for the wild swings in GDP/Total Work. (2) The average growth rate of Total Work is greater than growth rate of the population in the US. This means that the per capita total work generation has increased on average over the last ~3 decades. (3) The correlation coefficient between the growth rates for Real GDP and Total Work is 0.80. This is a fairly high value of correlation coefficient, but it's certainly not 1.0. (Note that the correlation coefficient between population growth and total work growth is only 0.22.)
Here's an interesting application of the graph above. Note the following two time periods: 1996-2000 and 2002-2007. In both cases, the "Real GDP" growth rate was higher than the "Total Work" growth rate. And then afterward, there was a huge drop in both GDP and Total Work output. It really seems as though we delude ourselves into thinking that we have wisely invested. Take for example the year 2006, in which the Total Work growth rate between 2005 and 2006 was nearly zero, but the real GDP growth rate was almost 3%/yr. Clearly people were thinking that they were making money, but there was no real growth in the capability to do work (i.e. wealth.) This delusion inevitably bursts, causing the chaos that invites more chaos until investors figure out how to make real wealth. For example, it wasn't until people started wisely investing in 2010 that the growth rate in Total Work went above 2%/yr. (i.e. it wasn't until investors in the US found projects with high rate of return on work invested, such as shale gas and shale oil development, that we started to see a real positive rate of return on work invested.)
It is likely that we will continue to delude ourselves and continue to go through these boom-bust cycles as long as we continue to use the same measurements of GDP growth as we have been using in the past. We can blame a lot of the boom-busts in previous centuries to the reliance on gold/silver as currency (and hence the boom-bust of debt-inflation when we found new supplies of gold/silver, which in no way are positive returns on work invested, i.e. the mining of gold/silver consumes work without any return on work invested unless you use the gold/silver as a catalyst for some chemical reaction or as a wire for some electrical process that might have a positive rate of return on work invested.) Currently, we can blame the boom-bust cycles of 1996 to 2010 on our fiat money system and the incorrect way that we calculate economic output (Real GDP.) As shown above, it's easy for us to delude ourselves that there is real growth when there isn't any real growth in the capability to do work.
The economy, whether you like it or not, is simply a means of increasing our capability to do real physical work, such as electrical work or mechanical work. The means of increasing the amount of physical work that we can generate is to invest work into projects that have large, positive rates of return on work invested.
In other words, a project (such as a power plant) should generate more work (electricity) over its lifetime than it consumed in the process of construction. For this reason, we can not consider current rooftop solar panels to be power producers. The panels consume more useful work to build and install them than they will generate over their lifetime in most locations (, see pg 27 of this link for a negative rate of return on investment for rooftop solar in Michigan. The author calculates a positive rate of return on investment in Hawaii (1-3%/yr on pg 32), but remember that the panels weren't created in Hawaii, the panels were likely built in China. The question is: what is the rate of return on investment when calculated using the price of electrical and mechanical work used to build and install the solar panel?) The only reason that people build rooftop solar panels is that governments are subsidizing the panels. Why should governments subsidize projects that consume more physical work than they generate over their lifetime? What is the point of a project with a negative rate of return on investment?
If you, like me, want to see the US, Canada, Japan, and Europe return to real growth rates of 5%/yr or more, then we all need to invest in projects that yield returns after taxes of greater than 5%/yr. We don't need to wait for some politician to change the laws of the land. We just need to figure out where we can invest such that after tax returns are greater than 5%/yr. In the past, oil production, steel production, and electricity generation used to generate rates of return on investment easily greater than 10%/yr. Such returns can sometimes be found in the computer hardware/software sector, where the use of computers can increase the returns from those sectors of the economy in which real physical work can grow (power plants and oil/gas production.) All others sectors of the economy are dependent on the average rate of return on work invested in energy sector, and therefore, they are important based off of their ability to help improve the rate of return on work invested in the energy sector. This also includes the farming sector of the economy, which a hundred years ago used to be independent of the electricity/oil/gas sector, but now it's completely dependent on the energy section and has turned into a subset of the energy section, i.e. that sector that feeds the people required to keep the economy going.
So, in conclusion, you have in your hands one way to possibly predict and anticipate future crashes in the market (note that there are a lot of figures of merit to watch, such as price per earnings ratio and the housing prices to rental prices ratio.) When the "Real GDP growth rate" stays above the "Total Work growth rate" for a protracted period of time, this suggests that a down-turn in the economy is likely. The cause of the downturn is the delusion of good investing and the friction associated with realizing that you have made bad investments. The friction during the crash is due to the movement of goods from one place to another (i.e. consuming work) without any financial gain (i.e. generation of work.) Government stimulus can't avoid a downturn unless the government knows of projects with significantly high rates of return on investment that somehow the market does not know about. Government stimulus towards projects with negative returns on work invested (such as welfare, bridges-to-nowhere, rooftop solar panels, corn ethanol, housing subsidies, and military waste) can't turn around a bad economy. In fact, stimulus will just make the economy worse because the overall growth rate of the economy will be worse off after the stimulus. Europe needs to learn these lessons really quickly or else it will quickly see its economy shrink year after year after year. Nobody is more careful about your money than yourself, so invest your money wisely, don't delude yourself into thinking that your home is a positive rate of return on work invested, and don't let governments convince you that they should inflate the money supply in order to spend your money better than you can spend it yourself.