Yves here. This is a terrific talk in which James Galbraith, recapping his work in Entropy Economics, explains how the foundations of economics are fundamentally at odds with the operation and limits of our physical world. Trust me, either put it on for a listen or find the time to read the transcript. Galbraith offers a fresh and important view of where what presents itself as economic logic is dead wrong and how we might go about making better policy decisions.
By Lynn Fries. Originally published at GPENewsdocs
LYNN FRIES: Hello and welcome. I’m Lynn Fries, producer of Global Political Economy, or GPEnewsdocs. Today’s guest, James Galbraith, will be discussing his new book, Entropy Economics: the Living Basis of Value and Production. In the book, James K. Galbraith and co-author Jing Chen, present an economic theory tied to the living basis of value and production- an entropy theory of value and a biophysical theory of production. The book contains a full exposition of the theories and supporting maths. James K. Galbraith is Professor of Government and Chair in Government and Business Relations at the University of Texas at Austin. Welcome James.
JAMES K. GALBRAITH: Thanks. Great to be with you.
FRIES: In Entropy Economics, your very first words are to say that: In this book, we present an economic theory that is consistent with life processes and physical laws. We do this because it is necessary. From there you comment on why. Let’s start there. Tell us why.
GALBRAITH: Well, it’s an effort to restate some of the most foundational questions in economics. And in particular, two issues that have bedeviled economic theory for quite a long time now, hundreds of years, really: The question of value and what determines production. These we argue are very basic questions that have been treated in standard economics, textbook economics, and the underpinnings of modern policy in ways which are profoundly inadequate. And that do not reflect the way living systems, living economies actually operate. So what we set out to do was to provide a tractable, simple alternative to the standard treatment of these questions.
FRIES: Why did put the the second law of thermodynamics, so the law of entropy at the foundation of the economic theory you present in this book?
GALBRAITH: The second law of thermodynamics is the most fundamental law of nature. The reality is that an economic theory which is based upon these very ancient classical concepts of supply and demand with roots going back to thousands of years into Chinese philosophy, actually, is not conscious of, does not take account of the basic processes that underpin all material systems and all living systems. And that is going to get you into trouble when you try to use the subject for any practical purpose. You’re just not going to understand the world around you. You’re going to think, for example, that markets are self-organizing. And they aren’t. The reality is there are no sophisticated markets, in fact, there are practically no markets that are not subject to regulation. That’s to say, it is government that sets up the conditions under which markets can function. This is a very basic fact. Anybody who lives in a relatively wealthy country understands that regulations are everywhere. Good ones, bad ones, but they condition our existence. And the notion of the standard view is that they should be reduced as much as possible. But when you actually do that, you reduce the capacity of life, of the efficiency of the system, the quality of living standards. And you regress the society from a wealthy to what we used to call a third world standard.
FRIES: There’s a lot to unpack here. The concepts of supply and demand that you refer to are of course the key terms of reference of modern mainstream economics which is theory of equilibrium. This theory, you say, does not take account of the basic processes that underpin all material systems and all living systems. In the book, you say that there are two fundamental properties of life.
First, living organisms must extract resources from the environment to compensate for the continuous diffusion of resources required to maintain various functions of life. Second, for an organism to be viable, the total cost of extracting resources must be less than the value of resources extracted. (P147)
As context for viewers on how entropy fits into this, I will briefly mention two observations you made in the book. Speaking of yourself and your co-author, you say:
As we and others have said before, from a physics perspective, resources are low-entropy materials (Georgescu-Roegen 1971). The entropy law holds that systems tend towards higher entropy states spontaneously. Living systems, as non-equilibrium systems, need to extract low-entropy materials from the environment to compensate for their continuous dissipation. (P147)
And the second :
Entropy is a measure of scarcity in physics. With this in mind, we can say that an entropy theory of value is a scarcity theory of value. All physical systems tend to move from a less probable state to a more probable state. Entropy is a measure of physical probability at a given time. The tendency of directional movement is what drives, among other things, all living organisms. In formal language, systems move from a low-entropy state to a high-entropy state. This is the second law of thermodynamics, the most universal law of nature. (P64)
Any one doing a search to make sense of that will likely run into a lot of talk about heat death. So for the purposes of today’s conversation, how do you suggest we should we be thinking about entropy?
GALBRAITH: There’s often a tendency to think about – in the common parlance of the term – entropy as being the tendency toward heat death – toward maximum disorder, toward the final state of non-organization of the universe. But the way we think is more useful for this purpose is to think of it as that essentially any work that you want to get done, any living process has to tap into available low entropy resources. And of course of using them, transforms them into much higher entropy waste. And so in some sense, that’s what the economic process is.
FRIES: For any work you want to get done, what are some of the available low entropy sources you have to tap into? Give us some real world examples.
GALBRAITH: Any use of a source of energy – wood, coal, oil, natural gas, uranium – in part you get useful work out of it but there are waste products. You dig a mine and you go after the gold or the lithium or whatever it is and there’s a lot of crest walk and other toxic waste that is the result. So you’re pushing for the low entropy high quality resource and generating a great deal of stuff that you can’t use along the side alongside it. What’s difficult here is not thinking of an example, it’s trying to think of a counter example. Because, in fact, there aren’t any. This is really, again, just basing an economics on the way physical processes actually work.
FRIES: As we go along we can clarify all this further as well as how entropy and equilibrium stand in contradiction to each other. As put in the book:
…equilibrium and entropy stand in contradiction to each other; you can have one but not both. And while entropy is a universal law of nature, equilibrium is nothing more than a figment of economic models and the imagination of their creators. (Pxiii)
Let’s turn now to the entropy theory of value you present in the book. Tell us something about that.
GALBRAITH: What we do in the book – I don’t want to make this appear to be more complicated than it is – we present a very simple description of the process of generating economic value. Which says economic value – what you can sell a product for and what it takes to bring it into production – depends upon two things. One is how scarce is that product relative to the potential demand for it? Does it have an interest in comparison with other products that are available – interest to the buyer? And the other is how many suppliers – how much monopoly power? Monopoly and oligopoly are very common ways to generate economic value.
FRIES: Let’s turn now to a theory of production. The neoclassical production theory in mainstream economics neglects resources. Your biophysical theory of production puts resources first. Your focus on resources spans – their quality, their costs, and the fixed investments required to obtain them. In the book you note that your approach is consistent with that of Nicholas Georgescu-Roegen and long before him William Stanley Jevons and more recently the biophysical school. Comment now on production theory and the resource question. In short, why putting resources first matters.
GALBRAITH: All living systems, all mechanical systems, all social systems rely on the ability to take resources from the environment and use them. In order to do that, you have to make a fixed investment. In order to extract sunlight from the sky and turn it into a usable fuel – food- a tree needs to grow a leaf. In order to power a car you need to have dug a well or a mine to get the source energy out of the ground. And the same is true of social systems. The same is true of economic systems. In the period in which our mainstream conventional economic theory was developed, the subject of resources could be largely overlooked because they were abundant and they were therefore cheap. And the way we do conventional accounting would tell you, oil isn’t all that important. It’s only 2% of GDP or something like that. But this is a profoundly misleading way of looking at the problem because there are things which may be a small part of the monetary value of an economy but, nevertheless, if they’re removed everything comes to a halt.
You need to have an economic theory and a way of thinking about value and production which takes account of that. I think anybody who’s ever seen a ghost town that used to be a gold mine understands that – even though there were lots of things in the town that were not directly associated with the mining of gold – once the mine dried up there was nothing left. And no reason for it to continue to exist. And this is the same is true on a larger scale as core energy resources become scarce. So you find, for example, that in Europe as they closed down the nuclear power plants and as the supplies of inexpensive natural gas were cut off and they have to rely on much more expensive LNG from the US or wind towers that are erratic, that the cost of resources goes up. And the profitability of their existing investments and prospective investments falls. And you run into serious problems of sustaining industrial activity, economic of all kinds, on that basis. So we put the resource question very much at the foundation of a discussion of economic issues because it is at the foundation of economic life.
FRIES: James, you claim one of the advantages of a non-equilibrium theory is that as it is consistent with life processes and physical laws it turns economic theory into a reliable tool for the assessment of the biophysical reality that human society has to engage with.
In the book, you demonstrate how your theory can and has been applied across a diverse range of investigations in many fields of study. To give us a glimpse into that, let’s look into one of the investigation’s you report on in the book. Specifically the investigation covered in the chapter on – Life in a World Without Equilibrium. And as presented in the book you wrote:
In this chapter, we investigated further how the physical environment enables and constrains living organisms and economic systems by integrating the economy of human society into the economy of nature. We explored the relation between natural resources and technology in human society. This helps us envision the future of human society in an environment of increasingly scarce and costly natural resources. (199)
You then summarized six main results of this investigation. Let’s briefly review those results. I think the first one was that: The survival and prosperity of human society depends entirely on the availability of natural resources.
GALBRAITH: On the availability and abundance of relative inexpensive access to resources. Sure. And so as particular resources are depleted, as they run out or if you decide they’re insuperable environmental constraints to using them, then you’ve got to expect that the profitability of activities that relied on those resources will fall.
FRIES: Let’s expand on that and the second main result summarized as follows: Although the forms of natural resources are diverse they can be understood from the unifying principle as low-entropy sources.
GALBRAITH: It means they are high quality but it also calls attention to the fact that the use of those resources degrades them. That you get some work out of it. You inevitably have some waste. So you can’t really escape from the fact that there’s pollution of one kind or another. And that is to say conditions may be different in one historical period as compared to another.
FRIES: Let’s Expand on this a bit, before we address later on your third main result. So, if I understood this correctly from the book – the rise and collapse of civilizations that marked the transitions of historical periods has a lot to do with civilizations reaching a state of high entropy.
GALBRAITH: We’ve had lots of civilizations and you can see the ruins of them all over the place. On every continent, you can see the residue of grand civilizations that have existed at past times. For one reason or another, they cease to exist. What tends to be in common is that the cost of maintaining them increased as they age, climate conditions changed, access to water changed, they deforested their surroundings and lost access to abundant sources of wood energy and on and on. Then you can see the effect of that is that typically the civilization collapses. To say that this is not something that can ever happen to us is profoundly at variance with the long-term experience of human society.
FRIES: On the point about the long term experience of human society that you made, for further context we should note observations you make about the current structure of our civilization. As you say in the book:
Today, most energy needs of human society are provided by fossil fuels. We often call our civilization the ‘fossil fuel civilization’. Coal, oil and most of the natural gas are from ancient biological deposits. These biological deposits, which formed over millions of years, were transformed for use by human societies over the past several hundred years. The abundant use of fossil fuels is the foundation of economic prosperity for many people the world over. (P184)
Comment further on our society’s use of what from a physics perspective are high quality low entropy resources.
GALBRAITH: The fact is our civilization depends upon concentrated solar and to some degree atomic energy that has been built up over a very, very long period of time. And which is essentially a very high quality low entropy resource in a way that sunlight falling on the earth is not so easily harvested, not so efficiently harvested. So we are naturally drawn to the high quality resources because they’re economically advantageous and they permit us to have a much higher standard of living than than we would otherwise have. What’s interesting about this is not that it’s a new thought – any natural scientist can explain this to you. It’s that the textbook economics – which dominates teaching and thinking and policymaking – holds that the self-organizing properties of markets and the balance between people who wish to buy and people who wish to sell will give you a stable and sustainable flow of goods and services without reference to the underlying technological conditions. And as if this is a story that technology is basically coming down from science. When, in fact, technology is chosen in the act of making investments.
It’s a profoundly unrealistic view which came into prominence for ideological reasons basically at two points in history. One was in the late 19th century when it was dragged out to counter Marxism which held that value arose in the process of labor. And then in the Cold War period, when it was again dragged out to counter the model of development that was being posed by the Soviet Union. Saying – You really don’t need to have planning. You don’t need to have government regulation. Not only the Soviet Union but the New Deal to create an ideological climate in which you could retreat from the New Deal. And that, of course, was politically successful. But it has also led to this situation now where we’re in an increasing state of decay. And those societies which operated on sounder engineering principles have moved ahead very rapidly by comparison with the Anglo-American model of market self-organization.
FRIES: You have given us historical context on the situation we face today. As put in the book:
The consumption of high-energy-density fossil fuels is the foundation of economic prosperity enjoyed by human societies in the past several hundred years. (P187)
And how:
In the past several hundred years, with the large-scale use of fossil fuels, higher fixed-cost social systems did well most of the time, expanding to a global scale. (P136)
The standard economic theory states that natural resources are only one factor in economic activities, that they can be easily substituted by other factors, and that output can be augmented by increases in technology. (P181)
Neoclassical economic theory contends that markets can overcome a scarcity of resources and direct our attention to changing technologies. But from a biological perspective, a different answer emerges. (P130)
From your perspective of thermodynamic law and entropy economics, to shift away from this dependence for whatever reason calls for planning. As put in your Future of Economics blog:
To extract or use resources, for any purpose, from photosynthesis to nuclear fission, requires prior fixed investment.
All investment is made according to plans, encoded in genes, blueprints, recipes, and in societies in habits, regulations, laws and constitutions.
As you say technology is chosen in the act of making investments. The Anglo-American model and so mainstream view – that you really do not need to have planning – is not consistent with how things work in the real world. Talk more about the situation we have been led into due to this ideological climate, in the context we are discussing now – the relations between natural resources and technology in human society. More specifically, I am thinking here of read throughs you see into the present from observations William Stanley Jevons made in his book, The Coal Question.
GALBRAITH: Well, Jevons more than a century and a half ago pointed out that even though you may change the basis of your energy resource, in other words, at the time from wood to coal, that doesn’t stop you from increasing the use of all the resources that you were previously using. Because it’s costly to build the machinery that makes use of the new source of resources. And that’s essentially one of the things that’s going on now. And because when a new new resource comes into play, new uses for it are developed.
To give an example that post-dates Jevons by half a century or more: the New Deal in the United States was based upon the arrival of two major new sources of inexpensive and abundant energy. One of them was oil. It was just first discovered on a large scale in East Texas around 1930. And the other one was the hydropower resources that enabled electrification of the Tennessee Valley of the Pacific Northwest and lots of other places as well. And that meant you could build electrical transmission lines. And you could provide power to rural households. And that meant that they could acquire lighting, but also very importantly, appliances. And that created a whole set of industries. Similarly, the discovery of abundant sources of inexpensive oil meant that you could power an automotive industry and an aviation industry that previously couldn’t exist. And so they set out and paved the roads and created the transportation network that we have especially from the 1950s onward with the interstate highway system. So this is a way in which energy resources feed into the larger development of an economic system.
Again, as I said, that the idea that you can constantly substitute away from the existing sources into new ones and leave the existing ones in the ground, if you like – even if it’s deemed necessary for environmental reasons – it poses extremely daunting challenges which we have not actually successfully addressed. And as we put money and resources into renewables, which we’re now doing, what we discover is that this then enables us to power data centers and artificial intelligence which soak up the new supplies of electrical energy. And without successfully reducing the use of carbon emitting sources, we aren’t doing anything serious to support the environment.
FRIES: In a comment on this in Entropy Economics, you wrote:
Even the massive investments underway in renewable energy sources – in harvesting sunlight directly – are both intensive in their own use of fossil fuels and serve as an addition to, not a replacement for, the consumption of fossil fuels in the present ordinary uses. This is just as Jevons predicted, a century and a half ago. (P196-197)
So massive investments underway in renewable energy sources are serving as an addition to, not a replacement for, the consumption of fossils fuels so as you say, not doing any serious to support the environment. And on top of that, these investments are intensive in their own use of fossil fuels. That latter point being the third main result of the investigation that we are reviewing summarized as follows: To utilize natural resources, fixed structures are required which consume resources themselves. In other words, fixed structures – so technology – is required to harness entropy flows and these fixed structures themselves consume resources. To expand on that point, comment on how resource conditions and the technical ability to utilize resources is critical. And how larger fixed investments are more efficient at harnessing entropy flows but they are more vulnerable in a changing environment. Why is that?
GALBRAITH: It’s very important if you want to have a highly efficient system to build up a structure of fixed investments that can use resources the most effective way. But there are two difficulties with that. One is that, that requires a climate of relatively low uncertainty for it to be considered profitable. If you’ve got a lot of uncertainty about whether there’s going to be a war or some other natural or human disasters lying ahead, the estimates of the profitability of a major investment drop very sharply. And similarly, if you build an efficient system and conditions change – resources become more expensive, interest rates are raised – the profitability of a highly efficient system, high fixed cost system falls much more rapidly than is the case for a more primitive low fixed cost more flexible system. So efficiency and fragility in the nature of things, go hand in hand. That’s a crucial point which you simply can’t easily get out of an understanding of textbook economics.
To gain access to usable resources, you have to make investment. And as the quality of the accessible resources declines, as they become more scarce, more difficult, then the scale of that investment increases. And here again, you get into the what is an essential dilemma which is the more efficient and longer term and effective and productive your fixed investments are – the riskier and more fragile the system. You build a dam. You build a very big high dam. If something happens to it, the potential for a catastrophe is much worse than if you are building just a small one. If you build a nuclear reactor, you have a very efficient way of generating electricity. But if something goes wrong and the containment is breached, then you have a very serious ecological and health catastrophe. And one can go down the list.
So, one thing we would need to realize is that if we play with the stability of the environment – if we use the central bank to raise interest rates for this I think completely silly and a false objective of fighting inflation by trying to control the interest rate – you are destabilizing the profitability of long-term investments. Which is something by the way that the renewables energy sectors experienced in the last half dozen years. A lot of projects for offshore energy production, they may or may not have been a good idea. But it was one thing to enter in those projects when capital was available for 2%. And quite another thing, when it’s 7% or 10% that’s the rate of return you have to earn. And as a result partly of that, a good number of these projects, which were envisaged a decade ago, have been canceled.
FRIES: The point you just made about the rate of return brings us to a further main result of your investigation: When certain structures can generate positive returns on the use of natural resources over an indefinite period, these structures are called living organisms. As you say in the book:
For any biological or social system to survive and prosper, it must provide a non-negative rate of return and sustain that return over time. In finance theory the performance of a business is measured by its rate of return on monetary investment. In biological theory, the performance of an organism is measured by its rate of return on biological investment. The return on biological investment is ability to sustain, reproduce, and grow a population. In energy extraction, the rate of return is measured as ‘energy return over energy invested’…defined as the amount of energy devoted to the extraction of energy from the ground, the atom, or the Sun. (P131)
In a detailed discussion of elements of your biophysical production theory, you explain the return-based theory you present in the book can help us understand why a system does well or fails in achieving its long term goal of survival and reproduction. And how:
A return-based theory allows us to analyze the long-term effects of own behaviors, the strategies of our businesses, the structures of our societies and the policies of our governments. (P132)
So, what you are saying here is that whether a system survives and prospers depends on its ability to generate a positive return and sustain that over time. Which I take should not be confused with achieving maximum profits or utility in the short term.
GALBRAITH: That’s exactly right. The issue here is whether they generate a positive return. This is not the same thing as maximum return. There is a trope in the economics literature – which owes to luminaries like Milton Friedman and others and in the way in which students are taught to apply the very simple minded mathematics that they’re given – that the object of a business enterprise is to maximize its profitability. It’s a complete sophistry. Businesses do not need to maximize their profits. They only need to have a positive profit. If they have a positive profit, they’ll survive. If they have a negative profit, they may be maximizing their profit and still coming out at a loss. And in that case, they won’t survive. So the notion that profit maximization is some core principle of business activity is simply an error. It’s a sophistry.
FRIES: A further question about the rate of return. So as noted earlier, the rate of return in energy extraction is measured as energy return over energy invested. What do we know about where that is trending for a major fossil fuel, say oil?
GALBRAITH: We know that oil has become much more expensive, generally speaking, to extract. When the first fields were found, you basically just stuck a pipe in the ground and out it came. Now you have the expense of fracking, breaking up the shale so as to release the petrochemical. It’s more expensive. And offshore is more expensive and more risky than onshore drilling and so forth. So the return on energy invested in high quality, low entropy resources has declined over the last century very substantially.
FRIES: That brings us to a fifth main result of the investigation summarized as follows: It’s the unique chemical properties of carbon that enable it to become the backbone of life. The major non-renewable energy sources that our industrial civilization builds on – so coal, oil, natural gas and so on – are generated from the remains of living organisms. They all contain carbon.
There is a detailed discussion on this in the book but for today’s conversation just give us some idea of where you are going with this.
GALBRAITH: Well, this is not a book to extol the virtues of carbon. It simply underscores the fact that carbon is the basic building block of life. And there are reasons in the structure of the carbon atom that has given it that, if you like, privileged position. And that resources on in which we have built our civilization are largely based upon the remains of past living organisms. Which used those chemical properties to create structures that they could use to exploit the environment. That’s largely at the microbial level, if you like, in so far as we know about the origin of oil and coal and natural gas. But that, nevertheless, tells you that you would have a very difficult time basing activity on something else.
It’s a clear fact that our life forms are carbon based. And the energy that we use is characteristically a mixture of carbon and hydrogen. This is what a hydrocarbon is. The more hydrogen that’s in that mix, the lighter and more efficient and less harmful the energy that you get out of it is. Which is why oil is lighter than coal. Natural gas is lighter than oil. And we can use oil, for example, in transportation more efficiently than coal. We can use natural gas in home purposes. We can pipe it into our homes and use it in our stoves and in our home furnaces, for example. It’s very satisfactory but it is higher quality and it will be exhausted more quickly because we use more of it. Coal on the other hand is very abundant, very heavy, harmful to use but it’s there. What we tend to do is use the coal to generate electricity, transforming a heavy source of energy into something that is essentially weightless – electrons transferred over wires – but with this very substantial and high economic cost.
The essence of this is that our argument is that while there are people who believe that we can move to a primarily hydrogen based economy, the resource situation doesn’t suggest that that’s likely to happen over the long term. What’s likely to happen is that we’ll exhaust the high quality fuels and then we’ll be back in a century on these enormous still existing coal reserves. Which isn’t very happy news for the environment, frankly. But it does raise some very profound questions about the future interaction of human society and the planet.
FRIES: That’s one of the profound questions about the future interaction of human society and the planet that you delve into in the book. Other major concerns for resources, climate, demography and so the future of our species are raised in the sixth and last of the main results summarized as follows: Our industrial civilization is bringing on a combination of increased high-quality resource costs, a warming climate, rising sea level, and declining human fertility. Comment on those major concerns.
GALBRAITH: Okay. Let me take up the question of fertility because it is, if you like, the micro – the household level or the family level – expression of the same basic principle, we would argue. Why is it that fertility levels have fallen so sharply but not in the poorest countries of the world, but in the richest ones? We would argue, we do argue that you can analyze the question of human demography and the decline in fertility along very much the same lines that we’re analyzing what is happening to our industrial systems, our transport systems, and other aspects of our large scale economies.
A household is a decision making unit. It has a set of fixed costs that it has incurred in setting up the household. That is to say typically a mortgage, typically, maybe an auto loan, tuition payments, and so on and so forth. And it has variable costs which are the regular costs of energy and other resources – food – that it has to use on a day-to-day basis. Well. what has happened is that over the last 50 years, the typical household, has seen the margin between its income and its costs get squeezed. In particular, the fixed costs have become more and more onerous. And the result of that is that it seeks economies. And what can you economize if you’re, let’s say, a relatively young family? The answer to that is you can have fewer children. You have fewer children because having children is a very costly endeavor and commits you to a long-term body of expenditures. And reduces the amount of hours you can put in in the workforce. Reduces the amount of disposable income you can enjoy. People all over the wealthy world have been making exactly the same decision. In the early post-war period in the United States, we had a baby boom. Why? Because you had lots of young couples with the cost of having children – with public education and very low utility costs and lots of new investment in infrastructure – was relatively low. And so people had children with abandon. Then as the energy crisis hit in the 1970s and the great financial crisis in 2008 – each of these events which made household finances more and more precarious – the fertility rates declined. And as I said, this is not just the United States, it’s the entire wealthy world. It’s not so true of poor countries where fertility rates are still quite high. Although they are declining in poor countries as well.
Now what’s going on here? This is actually a problem that classical economists understood very well. Adam Smith writing in the 1770s, noted that in North America in what was about to become the United States, a young widow with six or seven children was courted as a sort of small fortune. Because each of those children was worth a hundred pounds net gain – which was a lot of money in those days – for their labor on the farm. And so they were an economic advantage. Which he said was not the case in England, not the case in continental Europe, where a young woman in the similar position was basically destitute. In North America there was a, let’s say, not desirable position to be in but one which had very strong economic rewards. Well, that’s not true in our modern societies. In our modern societies, you have on the one hand a combination of a collective social security system, which takes care of old people. So you don’t have to rely on your own children. This is very good from a lot of standpoints. But also it reduces some of the economic incentive to have children. And at the same time, we’ve made the cost of having children – essentially past a certain point – practically prohibitive for middle class families.
So it’s perfectly understandable that if you’re pursuing policies of austerity, if you’re pursuing policies that don’t guarantee employment, if you’re pursuing policies that raise the cost – basically oblige you to educate your children well past the point of a free public education system, college, graduate school and professional schools and so forth and then they go off into the world – well, chances are you’re going to content yourself with a small number of them, one or two maybe. But very rarely will you see families that expand beyond that size. And the result of that when you multiply it out over the whole of the population of the wealthy countries is that you see, essentially, very severe declines in fertility. Which will mean in the near future – medium term future – very rapid declines in population. Not because resources are running out or that elderly people are dying off and not being cared for. But because given the way societies allocate their resources, it will be harder and harder and more and more expensive, relatively speaking, to have kids. And as the new generation, the new cohort is smaller, the future population will be smaller still. You already see this this dynamic. It’s happening in Korea. It’s happening in Japan. It’s beginning to happen in China. It was a serious problem in Russia because there were very few people born in the 1990s. And so, even though fertility at the moment is relatively good in the Russian Federation, the number of people being born is still quite small. The reason it’s not happening so much in the United States is straightforward. It’s simply that the US has a lot of immigrants. And the immigrant populations have higher fertility but they’re also just replacing the populations that are not reproducing themselves.
So, this is the way in which a doctrine of policy based on textbook economics, on neoclassic economics, has generated a set of conditions which have very severe long-term implications for advanced societies, for human societies in general. And there’s another reason why you need to understand what’s going on. I’m not saying that we pose an instant solution to these questions. That’s not our purpose. Our purpose is to say: Really economics should be about telling people things that they don’t necessarily want to hear. But that they need to understand in order to have a realistic view of what our problems are and think clearly about what might be done about them.
FRIES: Let’s talk more now about the mindset embedded in mainstream neoclassical economics that has generated a set of conditions which as you say have very severe long-term implications for advanced societies such as the one you just discussed and for human society in general.
In your blog, The Future of Economics, you commented that the purpose of Entropy Economics is:
…to detach economics from the 18th century mindset of equilibrium, rationality, and natural law and to embed it into the scientific discourse of the past two centuries, in line with physics, biology, and (almost) every other social science.
As you have said again and again, except for mainstream economics in most every other field of human knowledge, theories of equilibrium faded after the mid 19th century, when evolution and thermodynamics came to dominate scientific thinking. The economic mindset you are critiquing today then pretty much dates back to the 18th century?
GALBRAITH: Essentially, yes. But I would even say that in the long history of economic thought, economics has essentially been a court discipline. The basic ideas which originated in classical Chinese philosophy – an imperial court philosophy of stable conditions over long periods of time and which was not entirely unrealistic for that civilization and lasted for thousands of years – were imported to Europe in the 18th century. And brought to the French court by an enthusiastic sinophile named Francois Quesnay, the physiocrat. His doctrines were suited to the French regime before the revolution – before the French Revolution, before the Industrial Revolution. Adam Smith is a little bit of a transitional figure but he’s still rooted primarily in that era. Well, from the late 18th century to the middle of the 19th century was a period of enormous upheaval – political upheaval, economic upheaval, industrial upheaval. Transformation from a largely agricultural long-term society to one where the crucial economic activities – the ones that people were really focused on – were carried out in factories powered by steam, fueled by water, power, and coal.
And the premier analyst of that world was Karl Marx. Of course, Marx – being an exceedingly, clear-minded observer and harsh judge of the world that he was observing – was giving what was essentially a revolutionary doctrine, a doctrine with revolutionary political implications. And there was a reaction to that. And the reaction to that gave us the neoclassical economics initially developed in the 1870s. And then Keynes overthrew that in the 1930s and you had a period of practical policy that lasted in the US into the 1950s. And then the old idea, the ideas that these are static systems – equilibrium systems – came back. And the purpose of that was to undermine the notion that you needed to think ahead and understand the material conditions of economic life. The purpose of that is say: Well, we can just deregulate and break up monopolies and so forth and let the forces of competition handle all these problems. We don’t have to trouble our little heads about them. We don’t have to examine the sources of power that are driving our societies. That was the very convenient view which became the single way of thinking after 1980 when Margaret Thatcher came into power in Britain and Ronald Reagan in 1981 in the United States. And that’s what we’ve been struggling with ever since when dealing with the implications of it.
If you think about the problem of the existing society in which resources become more expensive, then you have to ask: do we really need everything we’ve built? Is everything we’ve got fit for purpose? And my answer to that is there are at least two sectors that we should be seriously downsizing because they pose a very heavy burden of cost on our societies for very little gain. One of them is the financial sector which has grown out of all proportion to its usefulness. Over the last 40 or 50 years become essentially a predatory entity on the productive economy. The other is the military which in addition to being a very costly thing to maintain is technologically obsolete and ineffective for its declared purposes and not providing security anymore. It’s a source of incomes for those who have access to the public – essentially to the public trough. But it does not provide security and the only thing that can provide security are security agreements which will operate at very little fixed cost.
But rather than cut those things, what we hear is that the problem is things like social security, things like health insurance. Which in fact operate very efficiently and do not involve enormous fixed costs. Because they can be functionally administered – if they’re done universally – at a very small cost. Reducing the fixed costs in order to make the system work better with more expensive resources is the way we should be thinking about the problem. We should not be doing this by pushing the cost down onto households where we see the result. Which, as I said, is the population is essentially given every incentive to extinguish itself by not reproducing itself. That’s what’s happening. And we have an alternative. We really have to reduce the amount of predators to allow all the ordinary people to live more easily and to make decisions that are more comfortable and less stressful for themselves.
FRIES: On the topic of economic theories of value, the book discusses the three classical schools of value theory – labor, utility and scarcity. And then goes on to make the case for a scarcity theory of value tied to basic life principles. That being your entropy theory of value. And the case that:
Since, for survival, all living organisms need to tap into the entropy flow, entropy is a natural measure of value for living systems, including human beings. (P64)
Give us some highlights of key aspects of that history which as you say has bedeviled economics for hundreds of years now.
GALBRAITH: Well, essentially, the Neoclassical school that came into existence and became dominant after 1870 was first of all a reaction to Marx. To say: Okay, the labor theory value, that really was not a scientific view. And instead we are going to root the value and price – and essentially conflate those two ideas – in human psychology. So we invent an abstract individual with a set of preferences. And we do spend a lot of time defining how those preferences are. Anybody who’s taken a course in economics would find this tediously familiar. They spend weeks and weeks trying to persuade you that something completely out of your notion of how people make decisions is how they make them. And then applying some mathematical formulas to that artificial construct. Obviously generations of students have had to really submerge their common sense in order to get through this stuff.
And we say: well, actually it makes more sense to talk about value in terms that would be familiar to Marx but are broader. We argue that labor is a low entropy resource. And in some sense, it made sense in the 19th century to think of it as the dominant one. But there are plenty of others including energy resources that you pull from the ground. And you can say: Okay, why did Marxist prediction that working population would be steadily impoverished, not come true? And the answer to that is that society figured technologies – figured out ways – to draw low entropy resources from the ground. And to distribute the benefits through industrial processes to the working population. So living standards rose. And people became substantially, dramatically, better off than they were in the 19th century, in the early period of industrialization. The 20th century was this extraordinary spread of the well-being which was made possible by mass production. Which was made possible by a really dramatically, improved use of high quality resources. So, again, that places us in the camp, I would not call us Marxist but certainly more consistent with the classical political economy view of how economic value is generated.
FRIES: You commented earlier that reducing fixed costs to make sure the system works better with more expensive resources is the way we should be thinking about responding to problems of increasingly rising resource costs hitting society’s high fixed cost system. We should not be doing this by pushing the cost down onto households and as you say giving the population every incentive to extinguish itself by not reproducing. As put in the book, a scarcity theory of value helps us understand one of the most pressing problems we are likely to face as a society, namely, the increasing scarcity, and economic value, of basic resources.
…the foundations of modern economic life, which rely on cheap and abundant resources, and on distributing the benefits of these – via service jobs, welfare payments, and pensions – to maintain the fixed cost of a stable society, will be threatened and possibly shattered. Indeed, we are already seeing the onset of this process, and it is causing a great deal of confusion among the economists and those who take their cues from conventional economics. (P196-197)
The fundamental difference between conventional economics and the economic theory you present in Entropy Economics as explained in the book:
The production theory presented in this book is derived rigorously from the fundamental properties of life systems. It gives simple and clear analytical estimates of returns to investment under different market conditions. It explains in simple terms why the cost of resources is critical to the profitability and measured productivity of any economic system, whether we consider an ordinary business firm, an entire country, or even a humble household. (P117)
So your theory of production permits you to take account of resources, fixed investments, expected profitability, and uncertainty – all critical elements in actual economic production. That, as you say, are somehow are abstracted away from mainstream equilibrium models.
GALBRAITH: We spend a fair amount of time on the Arrow-Debreu formulation which proved to be tremendously influential. Even though in fact when you read it carefully, it is pretty clear that it doesn’t establish what most people attribute to it. And that some of the things that they say that are assumptions for the existence of an equilibrium solution are simply impossible to envisage in any real world setting. They can abstract away completely from the passage of time or the change of the development of new commodities and so forth.
And so what’s the point of this except to provide some kind of ideological fog for avoiding thinking about how things actually work. And how things actually work is that businesses make decisions about what they’re going to bring to market. And they’re making that calculation and they are making it under uncertain conditions. And in periods when resources are cheap and abundant and people think we’re in a period of long-term peace and prosperity, they will make much more substantial decisions, much larger scale decisions. They think maybe I’ll have a global market. They’ll make a bigger investment and they’ll bring down the cost and improve the quality of what they’re doing.
Why is China succeeding in the world? The answer is first of all, it’s had a long period of stability. So there’s a mentality of stable development which has developed in China causing private firms to make large scale investments and highly automated processes, high quality. Which they can then market not only in China, which is a vast internal market and very stable, but to the whole world. You don’t need to have to invent a story of some magical communist genius thinking about how to do these things. Just understand that this is what happened in North America in the 19th century and in the 20th century as well what is happening now in the 21st century. But it’s in a different part of the world which actually created conditions for very stable markets in high scale production and big investments.
FRIES: I would like to delve further into the issues of the ideological fog you have been talking about and the related issue taken up in Entropy Economics about as you put it: Why is a biophysical approach resisted in modern mainstream economics, even though its main elements were very familiar in another era?
For that, I am going to draw on comments you made in your earlier book, The End of Normal, as well as from Entropy Economics. Specifically comments about one such prominent figure from another era. Nicholas Georgescu-Roegen whose masterwork, The Entropy Law and the Economic Process, was published in 1971. First you wrote in The End of Normal:
Georgescu-Roegen observed that economic reasoning as developed in the dominant traditions, was not in line with the second law of thermodynamics. This is the great principle that entropy constantly increases, that heat always travels from a hotter to a colder object, that time moves always forward and never back. Entropy is irreversible. Models of equilibrium systems, favored by economists and at the foundation of the growth theories, were by definition stable and even reversible. (The End of Normal, P97-98)
And second, in Entropy Economics in a direct quote from The Entropy Law and the Economic Process you wrote that:
In 1971, Nicholas Georgescu-Roegen observed that “there have been sporadic suggestions that all economic values can be reduced to a common denominator of low entropy” (The Entropy Law & the Economic Process, P283). Georgescu-Roegen’s observation has been often cited since, but there has been little progress in getting through to economists, who were brought up to a theory of utility and general equilibrium. (Entropy Economics, P65)
So essentially nobody wanted to hear it.
GALBRAITH: That’s right. We give due credit to Nicholas Georgescu-Roegen. We are certainly not the first person to suggest this. We also point out that at the time, the leading figures of the neoclassical School, Paul Samuelson, who I knew quite well, simply dismiss the notion that you should bring the concept of entropy to bear on economics. General equilibrium was not consistent with the entropy law. And they would rather have an unrealistic doctrine and unscientific doctrine that was consistent with their ideology than a realistic one with all kinds of uncomfortable implications. So we said basically the time for that kind of self-delusion, that kind of self-serving doctrine has, has clearly passed. It’s obvious that it has passed. The economists of my generation who grew up on the Samuelsonian view of the world, Milton Friedman’s view of the world, these were the people who came sort of traipsing into the Great Financial Crisis and were totally surprised. It couldn’t happen. No one could have foreseen it.
Whereas people who grew up with Keynes or with Hyman Minsky as their backdrop – or for that matter Georgescu-Roegen although he is not so directly connected to this question it’s very much a part of the same intellectual challenging community – were not surprised at all. You’re not necessarily going to predict that it was going to happen on a particular day but that it would happen. That the system was intrinsically unstable is just part of the worldview. If you understand how science in general has evolved since the late 19th century, since the Second Law of Thermodynamics became understood as the foundation of natural processes.
FRIES: Earlier in conversation, you touched an element of Cold War politics in how mainstream economics resists the biophysical approach. The politics of wanting to triumph on the side of market capitalism over communism or any other competing system.
GALBRAITH: And also over the historical experience of the American New Deal. Because in the American New Deal the public sector took over large scale planning processes. The Reconstruction Finance Corporation which ran out of the Federal Reserve – out of the regional federal reserves – was in control of long-term investment in the United States in energy and transportation. And in a vast number of other things, the government was in control of public investment – in roads and air fields and so on. And in the Second World War, something I know very well because my father was in charge, the government had control over prices. That was a public function to make sure that inflation did not undermine the war effort and destabilize the economy. And they had complete control over it.
So all of that reality was submerged in the post-war period. They didn’t get rid of Keynes entirely. Keynes was an extraordinarily important force in the 1930s in overturning the Jevons-Marshall supply and demand view of self-regulating systems. They didn’t get rid of that entirely but they tamed it. And Samuelson was a crucial figure in doing this. Something called the neoclassical synthesis. In which he allowed the government the role of a kind of a conductor of the train – it could turn on the brakes, on the gas and handle a few instruments – and then say for everything else, essentially the market model is okay. So we can compromise on this and have a better outcome than a planning system. In a condition of extremely favorable access to commodities and resources in the post-war period and the dominant position that the US enjoyed for other reasons – the fact that the war had really deprived Europe of its competitiveness, Japan had been destroyed and so forth – this worked for a while. It worked up until the 1970s and then it stopped working.
FRIES: So, I think you have given us all a very good idea of the full import of your opening words in Entropy Economics :
In this book, we present an economic theory that is consistent with life processes and physical laws. We do this because it is necessary, for a simple reason: the economic theory that underlies modern “mainstream” economics and practically all textbook teaching in economics is not consistent with life processes and physical laws. And this, we believe, is a problem. (Pxi)
So James, as we wrap up this discussion on the book, do you have any concluding remark?
GALBRAITH: I want to stress that we are not making here claims to some enormous scientific novelty. What we are doing is taking ideas which are very well established in biology and physics and in other social sciences and indeed in substantial traditions in economics which have been around for a long time. And going back, for example, to Thorstein Veblen and John R. Commons and to my father, frankly, as a leading practitioner, an exponent of this body of thought. So there’s nothing here which is let’s say path-breaking from a conceptual standpoint. What we’re offering here is an exposition and – I will give enormous credit to my co-author – a mathematical formulation which has not been made by other people, not been offered by other people. It is very simple. It is really something which people with really very basic mathematical training can generally absorb. And people who understand modern physics, I think will find very little difficulty with it.
But it enables us to say look…Very often the mainstream economist says: Well we have a theory and you don’t have a theory and you can’t fight something with nothing. Well, here’s a theory. Here’s a theory expressed in words. It’s based on a relatively small number of very clear principles about how the world works. And it can be summarized in mathematical terms. And in mathematical terms which are not just abstractions. You can actually plug in numbers and say: Well, this is how we think a given situation will unfold – a bankruptcy or the creation of a free trade area, or a decision to build a new factory or a project on a larger scale. And what will happen? Or what will happen if you do that and the interest rate changes or the situation becomes uncertain? All of those things can be just plugged into these equations and you will get – as we show in the book – reasonable answers. You’ll get a story, that you can actually more or less take to the bank as a plausible account of how these phenomena work.
And that’s something you really can’t do with the mainstream. The mainstream says in the long run, everything will converge to an equilibrium, provided you get rid of all the flaws in the fictions – monopoly and the asymmetric information and the externalities and the public goods and on and on and on. And if things don’t converge, it’s because you didn’t get rid of them. It’s an enormous tautology. You can’t do anything with it, really. It’s just a very flexible language to describe almost anything. That’s not what we’re doing. We say: Okay, we really ought to be able to say with reasonable plausibility what will happen in certain circumstances. And it ought to reflect, broadly speaking, the experience of the real world. And we think this does this. It in some sense says: Yeah, well, it’s not surprising that the principles that govern living systems and mechanical systems also govern social and economic systems. And if you think about it in those terms, you can apply these ideas in a lot of different ways.
FRIES: James Galbraith, thank you.
GALBRAITH: It’s been a pleasure.
FRIES: And thank you for joining us.
James K. Galbraith, Professor of Government and Chair in Government/Business Relations at the University of Texas at Austin, is a former staff economist for the House Banking Committee and a former executive director of the Joint Economic Committee of Congress. From 1993-97, he served as chief technical adviser for macroeconomic reform to China’s State Planning Commission. He is the co-author (with Jing Chen) of Entropy Economics: The Living Basis of Value and Production (University of Chicago Press, 2025).
